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.”
ETF investors can also target U.S. dividend growers through a number of options. For instance, the iShares Core Dividend Growth ETF (NYSEArca: DGRO) specifically targets companies that pay a qualified dividend, must have at least five years of uninterrupted annual dividend growth and their earnings payout ratio must be less than 75%. DGRO shows a 2.29% 12-month yield.
The Vanguard Dividend Appreciation ETF (NYSEArca: VIG), the largest dividend-related ETF on the market, tracks U.S. stocks that have increased dividends on a regular basis for at least 10 consecutive years and has a 2.03% 12-month yield.
The Schwab US Dividend Equity ETF (NYSEArca: SCHD) includes 100 stocks based on strong fundamentals, such as cash flow to debt, return on equity, dividend yield and consistent dividend payouts for at least 10 consecutive years, and it has a 2.63% 12-month yield. The options is also the least expensive dividend ETF, with a 0.07% expense ratio.
The PowerShares Dividend Achievers Portfolio (NYSEArca: PFM) also selects companies that have increased annual dividends for 10 or more consecutive fiscal years. The ETF comes with a 2.20% 12-month yield.
The SPDR S&P Dividend ETF (NYSEArca: SDY) holds firms that have a minimum dividend increase streak of 20 years for inclusion and shows a 2.30% 12-month yield. Moreover, SDY follows a yield-weighting methodology that allocates a larger weight toward those with higher yields, so the portfolio leans toward more mid-sized companies.
The ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL) only targets S&P 500 companies that have increased their dividends for at least 25 consecutive years and offers a 1.90% 12-month yield.
The WisdomTree U.S. Quality Dividend Growth Fund (NasdaqGM: DGRW) includes companies with high long-term earnings-growth forecasts for the next three to five years and weights components based on the value of dividends they are expected to pay over the next year. DGRW has a 2.14% 12-month yield.
For more information on dividend stocks, visit our dividend ETFs category.
CORRECTION: Updated list of dividend ETFs.