As has been widely documented, the once hot utilities sector has fallen back to earth in a big way over the several weeks as financial markets price in rising odds that the Federal Reserve will raise interest rates in December.
That speculation is also weighing consumer staples stocks, which along with utilities, can accurately be described as “rate-sensitive.”
High-yield dividend stocks and exchange traded funds have been rewarding yield-starved investors for much of this year, but that trade has recently been threatened on concerns that defensive sectors, such consumer staples, telecom and utilities, are overvalued and that the Federal Reserve could be nearing its first interest rate hike of 2016.
A desire for defense and yield benefited ETFs like the Shares Select Dividend ETF (NYSEArca: DVY), which was one of the better-performing dividend exchange traded funds through the first half of this year.
Related: Low U.S. Interest Rates Boost International Dividend ETFs
For income investors, the good news is that some market observers believe high-yield dividend stocks may be able to weather Fed storms better than many investors are trained to believe.
[related_stories]Stocks with steady dividend yields reassure investors of a company’s strong financial health. Additionally, dividend-paying stocks typically outperform those that do not pay over the long haul, with less volatility, due to the compounding effect of dividends on the investment’s overall return.
Still, DVY could be vulnerable in the near-term because of it devotes about a third of its weight to rate-sensitive utilities stocks, one of the largest such allocations among all dividend ETFs.
“Utility yields look enticing when Treasuries are yielding under 2% but look less so when the yield gap starts closing. That’s already starting to happen as the market appears to be preparing itself for what feels like an imminent rate if not at the December Fed meeting then soon in 2017. Since July 1st, the 10 year Treasury yield has jumped from just under 1.4% to around 1.8%,” according to ETF Daily News.
Related: Low U.S. Interest Rates Boost International Dividend ETFs
The fortunes of the utilities sector seem to be tied to the Federal Reserve’s interest rate outlook. Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.
For more news and strategy on the Dividend ETF market, visit our Dividends category.
Shares Select Dividend ETF (NYSEArca: DVY)
Tom Lydon’s clients own shares of DVY.