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By Jeremy Glaser | 12-02-2010 07:12 PM

An Inflation-Beating Dividend Stock Pick

Paychex should be able to take rising interest rates and inflation in stride while still providing investors with a decent total return says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar.com, I'm Jeremy Glaser. I'm joined today by Josh Peters, Editor of Morningstar DividendInvestor to take a look at the potential of rising interest rates in the future. What impact that could have on dividend paying stocks.

Josh, thanks for joining me today.

Josh Peters: Jeremy, good to be here.

Glaser: So I know it's kind of difficult at this point to talk about rising interest rates, rates have been at almost historic lows for a long time now. But with the economy and the recovery really starting to look like its truly taken hold, it's only a matter of time before the Federal Reserve begins to raise interest rates. And a lot of investors aren't sure what kind of impact that's going to have on their dividend paying stocks. Can you walk us through what some of the first and second order impacts of that will be?

Peters: Yeah, I mean, I think it's not that hard to at least think about where interest rates might go, when you are starting at zero. I mean, obviously interest rates are notoriously difficult to forecast. Fed policies could be kind of a black box, even as more open the Fed has become here in recent years, especially under Chairman, Bernanke. But when you are starting with zero, it's not really a matter of – if or how much you don't just – when and how much.

So, I think that the Fed is going to, in all likelihood, want to keep interest rates low. They control the short-term interest rate, you know, have a peg close to zero. They can keep it there almost indefinitely, if they want to. I think they are going to want to keep that there. They may even continue as they have announced buying with their plan of buying in $600 billion worth of longer term treasuries to try to keep the long end of the treasury curve down, which is more relevant to things like mortgage rates and business borrowing costs.

They are going to want to do that until they see real conclusive evidence that the economy is off the mat, it doesn't necessarily need the crutch anymore before they actually start to take this crutch away. But before that happens investors are going to anticipate higher interest rates and people are going to have to reorganize some of their thinking.

One of the top things that I am afraid of is that a lot of people have moved into dividend paying stocks, just because rates on CDs and treasury bills and money market funds have been so low. If that's the case, they have traded something which is really just supposed to be a store value for a long-term investment that may be they didn't mean to make.

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