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A powerful force has emerged to break the fascination investors have with dividend stocks.

Yields in the bond and money markets are high enough that you can get 5-per-cent returns or more from bonds and T-bills. Investors are weighing the risks of dividend income versus bond interest and siding with bonds. The resulting price declines in dividend stocks give us yields of 6 to almost 8 per cent.

Yields that high are a warning – let’s be clear about that. Investors are concerned that some dividend payers will struggle to increase or even sustain their dividends, especially with the economy slowing. But high rates have a big influence on dividend yields, too.

The increasing gap between the yields of some blue chips and bonds is basically a risk premium for choosing stocks over bonds. There’s downside for potential for dividend stocks if rates stay high or increase, as well as the risk of dividend disappointments. Dividend growth for some companies has been slowing for years.

It can kill your confidence in dividend stocks to see them being thrashed. But that’s how buying opportunities in the stock market present themselves. A good time to buy always feels like a bad time to buy. And things could easily get worse for dividend stocks, as well as the broader market. If you buy dividend stocks now, think in terms of a minimum three- to five-year hold, or more.

Over that span, we should see interest rates start to decline from peak levels. There’s talk that rates will be higher for longer, but the economy will strangle without rates falling to some degree. As rates ease, money will start to flow back into dividend stocks. Prices will rise, yields will come down. Investors who bought dividend stocks when they were beaten down will be rewarded in three ways:

  • Potential price rebounds: Some blue-chip dividend stocks have fallen so hard lately that their share prices are down or flat over the past five years.
  • Dividend growth: Bond interest is locked in, but many dividend stocks have a history of annual dividend increases.
  • Tax: In a non-registered account, the dividend tax credit means you pay less tax on dividends from a corporation than you do on bond interest.

Dividend stocks aren’t broken or discredited. They’re in competition with high interest rates and, for now, losing the battle. A turnaround is coming.

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