Between June 2004 and June 2006, the Federal Reserve raised the benchmark interest rate to 5.25 percent from 1 percent. Over this period, the Dow Jones Utilities Average generated a total return of 59.6 percent—one of its strongest two-year performances on record.
Telecom stocks, real estate investment trusts (REIT), master limited partnerships and Canadian royalty trusts also posted robust gains over these two years.
These impressive returns against the backdrop of the Federal Reserve’s last major tightening cycle raise serious questions about the established wisdom that rising interest rates spell doom for dividend-paying stocks.
The rationale behind this fallacy holds that an uptick in interest rates erodes the value of future dividend payments. Although this reasoning might apply to bonds and other fixed-income securities, equity prices tend to track the health of their underlying companies.
A strengthening economy—a prerequisite for the Federal Reserve to begin raising interest rates—bolsters most corporations’ growth prospects, though investors should be wary of industry- and company-specific headwinds.
However, the bull market of the previous decade was only a few years old in 2004; the current uptrend appears to be on its last legs, as Elliott Gue warned in Black Monday: A Shot Across the Bow.
These differences aside, market history suggests that as long as dividend-paying companies continue to post solid earnings, investors have no reason to abandon their positions.
Although the Lifelong Income Portfolio (and dividend-paying stocks in general) has taken its lumps this year, second-quarter results suggest that our holdings continue to deliver the goods as businesses.