Despite many calls that the Federal Reserve will hike interest rates, yields may linger on the lower range historically, potentially leaving room for high-quality dividend growth stocks and related ETFs to shine.
“All told, there is no denying that rising bond yields represent a headwind for income stocks,” Richard Turnill, Global Chief Investment Strategist at BlackRock, wrote for the Financial Times. “But not all dividends are created equal, and we believe a focus on dividend growth is still likely to offer the dual benefit of income and potential for attractive relative returns.”
Given President-elect Donald Trump’s campaign promises, the markets believe a Trump administration could foster growth and fuel inflationary pressures, adding to speculation that the Fed would hike interest rates to rein in an overheating economy.
Consequently, many expect higher yields and a steeper yield curve are on the horizon. While income seekers may welcome the prospects, bond market yields may continue to remain in the low end of the spectrum.
“Structural changes to the global economy – ageing populations, weak productivity and the debt overhang following the global financial crisis – are a notable offset,” Turnill said. “These forces should limit growth and, combined with a glut of savings in emerging markets, put a cap on how high rates can rise. As such, yields are likely to reside in a lower range than they have historically.”
Consequently, there may be room for dividend stocks to run.
“And that means investors should not turn away from equities for income,” Turnill said. “In fact, we believe dividend growth stocks remain one of the most fertile fields for income seekers.”
Stocks provide over 70% of the income in a global 60/40 stock/bond portfolio, even after the recent rise in bond yields, according to BlackRock. In contrast, the average contribution was 46% since 1990.
While a rise in rates would diminish the attractiveness of dividend stocks with premium valuations and low growth, more high quality dividend payers or the group of dividend growers may stand out.
“We see dividend growth stocks, quality companies with enough free cash flow to sustain dividend increases over time, having an upper hand in this environment,” Turnill added. “They are less susceptible to rising rates than high yielders.”