Investment Strategy

Taking Profits to Follow Our Dreams

Conventional wisdom holds that dividend-paying stocks will take a hit when the Federal Reserve tightens monetary policy because an uptick in interest rates reduces the value of their future payouts.

Of course, this argument conveniently overlooks the potential for companies to grow their dividends, especially when you consider that the Fed’s rate hikes usually coincide with periods of economic strength.

This assertion also doesn’t hold water when you look at market history; for example, utility stocks, widely considered the most sensitive to interest rates, exhibit almost no correlation with the yield on 10-year Treasury notes over the long term and track the broader equity market much more closely.

(Click graph to enlarge.)

Nevertheless, this old wives’ tale continues to hold sway, causing near-term gyrations in utility stocks and other dividend-paying equities whenever the market expects the Fed to raise interest rates.

Never mind that during the Federal Reserve’s last major tightening cycle, when the US central bank increased the benchmark interest rate by 425 basis points, dividend-paying equities of all stripes actually outperformed by a considerable margin. (See Waiting for Yellen.)

For those who own dividend-paying stocks, these history lessons provide a bit of reassurance with all the ongoing speculation about when the Federal Reserve will raise interest rates.

When the Bear Bites

Unfortunately, dividend-paying equities’ correlation with the S&P 500 entails its own risks—especially during a bear market.