Quality, dividend-paying stocks and exchange traded funds have been among the best performers this year as investors turned to a relatively undervalued segment of the market following the sell-off in growth stocks. However, the dividend play has been losing momentum in recent months, underperforming broader markets.
High-quality, dividend stock ETFs have fallen out of favor. Over the past three months, the Vanguard Dividend Appreciation ETF (NYSEArca: VIG) fell 3.6%, SPDR S&P Dividend ETF (NYSEArca: SDY) dropped 5.7% and ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL) declined 6.6% while the S&P 500 Index retreated 3.0%.
The pullback in the dividend space may be attributed to the lower expected payouts ahead after a share of earnings paid out to shareholders surged in recent years.
[related_stories]According to FactSet data, U.S. companies have doled out a little over 38% of earnings in dividends, or close to the same percentage paid during the height of the financial downturn when the dividend payout ratio surged following a fall in earnings.
The trend of rising dividends may not last and could even reverse over the next year as rising bond yields make riskier dividend-paying stocks less attractive to investors.
In recent years, dividend stocks have been the go-to alternative for yield-starved investors as bond market yields plunged toward record lows. However, if yields push higher, the hunt for stable and regular payouts may subside, which may diminish demand for dividend paying stocks.
Concerns over dividend stocks are now growing after the recent uptick in bond yields and rising expectations for a Federal Reserve interest rate hike in response to a slowly improving U.S. economy and higher inflation. Yields on 10-year Treasury notes have increased to about 1.8% since the 1.36% low back in July.
While company dividends won’t dry up any time soon, investors are beginning to pare down demand for dividend-paying stocks.
For full disclosure: Tom Lydon’s clients own shares of SDY.
SPDR S&P Dividend ETF