Falling bond yields have been a consistent theme for investors in recent months, and one that came to the fore after the rate of return on the 10 year Treasury note fell to a 21-month low this week, while falling roughly 22% this year.
Equity investors have struggled to interpret whether low yields are signalling a coming recession, or merely the anticipation that the Federal Reserve will soon cut interest rates. But one thing is clear: as the yield on government debt falls, dividend-paying stocks become more attractive.
In fact, yields have fallen so precipitously that the average dividend yield of an S&P 500 (.SPX) stock sits at 2.078%, versus the yield on the 10-year U.S. Treasury note at 2.094%, a difference of less than two basis points, or 0.02%. Meanwhile, more than 44% of S&P 500 stocks yield more than 10-year government bonds, according to FactSet.
“It’s unusual for the 10-year to yield so close to the S&P 500,” Keith Lerner, chief market strategist at SunTrust Advisory Services, told MarketWatch. “This will help buffett the downside, because at some point investors need to earn something,” and there are plenty of high-quality companies that pay larger dividends than government bonds.
“With yields this low, you don’t even have to be particularly optimistic about the economy” to buy equities, he added. “Stocks could move sideways for the next ten years and would still outperform bonds by simply paying or increasing their dividends over time.”
This dynamic will create a buffer for stocks on the downside, Lerner said, and could be one reason that stock prices have risen over the past week, even as signs of slowing growth have also caused a rally in government bonds.
Trey Welstad, portfolio manager of the Dividend Harvest Fund at Integrity Viking Funds told MarketWatch that there are several attractive names investors could look to if they are hoping to flee low-yielding bonds for higher-yielding stocks of companies with a long track record and a stable business model.
He points to AT&T Inc. (T) as one candidate, as it has a dividend yield of 6.4%, and has increased its dividend for thirty-straight years. Though the stock has lagged the broader market over the past 12 months, declining 2.6% versus the S&P 500’s, 2% rise, the stock has performed better of late, trailing the S&P 500 by just 0.7% year-to-date. “Blue-chip stocks like AT&T can really power through tough times,” Welstad said, suggesting it could outperform in a sideways-moving or bear market, while still paying an attractive yield.
During periods of economic weakness high-dividend paying stocks may decline in value, “but that means you are going to be able to reinvest dividends at better prices,” while feeling confident that a large company with a long track record will eventually recover, along with the broader economy. “With Treasuries you’re going to have to reinvest at lower yields and higher prices,” he added.
Bond prices typically rise during economic slowdowns or recessions, as investors flee to the safety of government-backed debt. Bond yields move inversely to bond prices.
Welstad also likes include Altria Group Inc. (MO) which has raised its dividend for 49 years in a row, and is the ninth-highest yielding stock in the S&P 500 at 6.2%, according to FactSet. Over the past decade, Altria stock has produced an annual total return of 17.3%, versus the S&P 500, which sports a 14% total return over the same time.
Other high yielding names that Welstad favor include Kimberly Clark Corp. (KMB), Coca-Cola Co. (KO), and Exxon Mobil Corp. (XOM), which yield 4.2%, 3.1% and 4.6%, respectively. Each of these names has increased its dividend every year for at least twenty years.
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