This another year in which plenty of market strategists expect the Federal Reserve will raise interest rates. Perhaps that will happen in April. Or June. Maybe later.
There is also a chance the Fed will not hike rates at all, but assuming a rate increase comes to pass, investors will want to consider dividend growth stocks and some of the corresponding exchange traded funds.
“The consensus view for interest rates in 2015 is the same as 2014, that is, rates will end the year higher. If this higher rate cycle is realized, investors realize the impact on bond prices is a negative one. For stocks though, a higher Fed rate cycle historically is not a negative for equities. As the below chart details, during periods of rising interest rates, dividend growth stocks have generated higher, and positive, returns with less volatility,” according to Horan Capital Advisors.
Investors have an increasing number of ETFs that, through various methodologies, emphasize dividend growth in some form. One example is the ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL), which only includes companies that have increased their dividends for at least 25 consecutive years. [Dividend ETF Aristocracy]
What makes NOBL an alluring option among dividend ETFs is that even though the ETF is home to plenty of mature, old line companies, as evidenced by the 25-year dividend increase streak requirement, the ETF sports a yield of less than 2%. That implies ample room for dividend growth by the ETF’s roughly 50 holdings.
Importantly, NOBL features a combined weight of 40% to the industrial, materials, financial services and energy sectors, each of which outperformed the S&P 500 during the Fed’s last tightening cycle from 2004 to 2006. [Winning Sector ETF Ideas for Rising Rates]
“Investors should keep in mind dividend paying stocks historically dip lower an average of 9% during the first 3-4 months of the increasing rate cycle,” according to Horan Capital.
“According to S&P Dow Jones Indices, 971 dividend increases were reported during the fourth quarter of 2014 compared to the 885 increases which were reported during the fourth quarter of 2013. For all of 2014, 3308 issues increased their payments, up 14.3% from the 2895 issues that increased their payments during 2013,” said S&P in a note out last week. [Dividend ETFs Haul in Cash]
The potency of dividends and dividend growth in rising rate environments is not surprising because dividend growth, historically, tops inflation.
Since the early 1970s, when inflation ran as high as 11% per year, aggregate annual dividends of the S&P 500 have grown more than 1,000%, to $34.99 from $3.16 a share, Maxwell Murphy reports for the Wall Street Journal.