Dividend-Paying Equities Gain an Advantage

During the second half of last year, longer-term interest rates in the U.S. rose considerably—mostly driven by the expectation that the Federal Reserve (Fed) would begin tapering its quantitative easing (QE) program. As a result, the yield advantage dividend-paying equities had offered over the past few years started to close, which caused a rotation out of the higher-yielding sectors of the dividend market.

Surprisingly, even though the Fed has continued to scale back purchases of both mortgage-backed securities and U.S. Treasury bonds, interest rates have actually fallen year-to-date.1 More recently, the yield advantage dividend-paying equities offer has improved and the percentage of equities with a higher dividend yield than the 10-Year U.S. Treasury has increased. As a result, we have started to see a rotation back into dividend-paying equities.

The Impact of Fundamental Weighting

There is still a healthy part of the broader market that can offer higher yields than U.S. Treasuries, but since this part no longer represents the majority of stocks in the market, it would be hard to notice by looking only at large-cap indexes weighted by market capitalization. At WisdomTree we weight eligible companies in our Indexes by their Dividend Stream®, which enables us to magnify the effect of dividends. The figure below shows the weight of each index in stocks with higher dividend yields than the 10-Year Treasury.

Percentage of an Index with a Dividend Yield Above the 10-Year Treasury Yield

For definitions of indexes in the chart, please visit our Glossary.

Rates Have Fallen Year-to-Date – Through April 11, 2014, the 10-Year Treasury yield has decreased from 3.03% to 2.62%—a change of 41 basis points. To put this in context, rates still remain well below their monthly average of around 6.0% over the last 30 years. But as interest rates decrease, they provide less competition for dividend-paying equities, especially higher-yielding equities.

Higher-Yielding Equities Offer an Advantage – The WisdomTree Equity Income Index, which selects securities for inclusion based on dividend yield, has close to 90% of its weight in securities with a yield advantage over Treasuries. These higher-yielding securities, which underperformed last year as rates rose, have started to show relative strength against the broad market as rates have pulled back year-to-date.