Don't Dump Your Dividend Stocks
Yes, interest rates are headed north, but the bad news for yield-oriented stocks is already behind them.
Since the election, economists and pundits seem united in the belief that economic growth is about to accelerate, propelling inflation and interest rates to levels that we haven’t seen in years. If the Federal Reserve lifts short-term rates three times in 2017, as it has said it intends to do, holders of CDs and money market funds will benefit.
But higher rates and inflation portend peril for bonds and for stocks with high dividend yields. The yield on the 10-year Treasury bond soared from less than 1.9% on Election Day to 2.5% at the end of 2016, causing the bond’s price to drop by 3.2%. I don’t blame you if you’re not a fan of Treasury bonds. Neither am I. Although they’re supersafe from a credit-quality perspective, they still pay too little and are highly vulnerable to rising rates, as their recent performance shows.
Over in the stock market, utilities, telecommunications and other high-yielding groups lagged in the days after the election, as other sectors rallied. If you believe the rules of investing changed on November 9, you may have already trimmed or eliminated positions in such stocks as AT&T (symbol T, $43), Verizon Communications (VZ, $53), American Electric Power (AEP, $63) and Digital Realty Trust (DLR, $98). If you were quick on the trigger, you might have unloaded AT&T for $37.50 the morning after the surprise vote and felt justified when it dropped to $36.10 the following week. Or you could have sold Realty Income (O, $57), a real estate investment trust known for paying a dividend every month, for $58.35 at the outset of trading on November 9, then watched with satisfaction as it sank $4 over the next three days. (Quoted prices and yields are as of December 31.)
You get two cheers if you sold off your dividend payers and located better alternatives. But you earn three huzzahs if you resisted, or never even contemplated, such drastic moves.
Yield-oriented stocks have already rebounded from the initial bout of knee-jerk selling. And why not? Utilities and REITs should benefit, not suffer, if the U.S. economy perks up, inflation remains modest, and long-term interest rates, which are set by investors in the bond market, have already experienced the bulk of their “Trump bump” adjustment (Kiplinger forecasts that 10-year Treasury bonds will yield 3.0% by the end of 2017). Real estate and utility companies are built to last. Years of low interest rates and sound credit ratings have let REITs and utilities borrow cheaply and for extended terms. And although it’s fair to mock Verizon for offering to swallow hapless Yahoo (YHOO), AT&T will spread its wings far beyond phone calls if its proposed deal to acquire Time Warner (TWX) goes through. With a dividend yield of 4.6%, AT&T remains attractive for income investors.
A potent mix
Perhaps the best recipe for the year ahead will be to mix growth with income. Our slide show of 10 Great All-Weather Stocks offered a bunch of strong dividend-paying stock ideas. Since Election Day, none have fallen apart, and three—Berkshire Hathaway (BRK-B), the one non-payer on the list, and two dividend stalwarts, Automatic Data Processing (ADP, $103) and Magellan Midstream Partners (MMP, $76)—have jumped by double-digit percentages. Prices of two other stocks mentioned, Brookfield Infrastructure Partners (BIP, $33) and Digital Realty, essentially took round-trips. Both are longtime favorites of mine for growth and income.
Evidence that scary numbers of investors are sick of dividends simply does not exist. And whatever your politics, you can bet that a Republican-dominated government won’t raise taxes on investment income. That’s another reason to stay with what has worked so consistently.