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Will Rising Bond Yields Sink High-Dividend Stocks?

Is the conventional wisdom wise?

Maciej Kowara and Eric Jacobson, 02/16/2017

A market commentator wrote on Jan 18, 2017, that

"A stock that has no growth prospects and relies solely on future income expectations in determining its value closely resembles a bond or other fixed-income investment. Therefore, such stocks typically trade in line with the bond market. Rising rates hurt the price of bonds, and so stocks in low-growth industries also often fall in rising-rate environments."

We selected this quote not to single out the author, but because there seems to be an undercurrent of worry these days based on this kind of conventional wisdom about the risk to dividend payers in a rising-rate environment. (Articulating it may have even been the author's intent.)

High-dividend stocks do resemble bonds in some respects, and investors may indeed expect them to serve as bond substitutes in some portfolios, by the logic that when rates go up, they will lag or lose out to the broad equity market, because that's what bonds typically do when rates rise.

Is that really true, though? We find the evidence to support it rather weak.

Two Plots
We've put together a couple of charts to help illustrate the point. One shows how monthly returns of the broad stock market (vertical axis) have reacted historically to monthly changes in the 10-year Treasury yield (horizontal axis). The other chart is similar, but instead of comparing the broad stock market's overall returns to 10-year Treasury yield changes, it illustrates how returns from an equity portfolio with long exposure to high-dividend stocks and short sales on low-dividend stocks would have been affected by the 10-year Treasury's yield shifts.[1] We're using that construction to adjust for the return impact on dividend payers inherent in their being part of the market as a whole, and we think of that long/short portfolio as our "dividend proxy portfolio."




As you can see, the charts look very similar. Exhibit 1 shows the broad stock market on its vertical axis, and Exhibit 2 uses our dividend proxy portfolio.  If there is a relationship here, it's not obviously visible to the naked eye.

The most obvious qualitative conclusion from these basic charts is that changes in 10-year Treasury yields explain very little of the variability in either the broad stock market or dividend proxy portfolio returns.

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