The Federal Reserve is widely expected to hike interest rates next year. At this point, that’s old news. What investors are now pondering is how many times the central bank will boost borrowing costs.
Some market observers are wagering that there could be as many as three rate hikes, each in increments of 25 basis points, next year, and that the tightening could commence as soon as March, coinciding with a possible end of tapering.
Obviously, Fed tightening brings with it implications for dividend stocks and exchange traded funds, such as the ALPS Sector Dividend Dogs ETF (SDOG). On the surface, high-dividend strategies such as SDOG appear to be vulnerable to rising interest rates, but that might not be the case in 2022.
Yes, SDOG overweights some rate-sensitive sectors, namely utilities, relative to the S&P 500. However, the ALPS fund excludes real estate, another rate-sensitive group. Likewise, SDOG is more than adequately exposed to sectors, such as financial services, that are positively correlated to rising interest rates.
Add to that, there are correlations between dividend growth and rising interest rates, and that’s something to consider even though SDOG isn’t a dividend growth ETF.
“Over longer time frames, there is a general connection between a rising fed funds rates and dividend growth,” Citi strategist Scott Chronert writes in a note. “We suspect that this is implicitly tied to FF responding to stronger economic activity, with follow through to earnings and, ultimately, dividends.”
One way of looking at how rising interest rates impact dividends is that dividend-paying companies are aware of the fact that higher rates can prompt investors to embrace lower-risk bonds, potentially dumping shares of their companies’ stock in the process. To that end, executives know that if their company has the means to do so, it’s a good idea to raise dividends as rates increase.
“We postulate that a rising Fed Funds target rate could put pressure on corporate C-suites to make sure that respective dividend policies remain attractive to investors relative to other income alternatives,” adds Citi’s Chronert.
SDOG yields 3.15%, as of Dec. 7, well ahead of what 10-year Treasuries are likely to be at, even with rate hikes. Plus, plenty of the fund’s holdings are boosting payouts this year.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.