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By Jason Stipp and Alex Bryan | 08-29-2013 02:00 PM

Rising Rates and Your Steady-Eddie Stocks

Steady dividend-payers may be under some pressure as interest rates rise in the nearer term, but that's no reason to dump them, says Morningstar analyst Alex Bryan.

Jason Stipp: I'm Jason Stipp for Morningstar.

The recent rising-rate environment certainly took its toll on bonds, but how do stocks fare in a rising-interest-rate environment? Here to offer some great insights is Alex Bryan. He is a fund analyst on our passive investing team.

Thanks for being here, Alex.

Alex Bryan: Thanks for having me.

Stipp: You did a really interesting research report on Morningstar.com that looked at some of the trends, specifically [related to] stocks, in a rising-rate environment. But before we get to some of those, let's just refresh everyone on the difference between how stocks and bonds react when we start to see rates tick up.

Bryan: Fixed-income securities, or bonds, tend to be highly sensitive to changes in interest rates. And [with] bonds, most investors measure interest rate sensitivity by a measure called duration. Basically, bonds that have their cash flows further out in the future tend to be more sensitive to rising interest rates. That works in their favor, actually, when interest rates start to fall, but in a rising-rate environment, bonds that have their cash flows further out tend to do a little bit worse.

Now with stocks, it's different because cash flows are less certain with stocks than they are with bonds. Rates don't change in a vacuum, [and] in a rising rate environment, the economy is usually getting stronger in those times, and investors' expectations for stocks' future cash flows may rise as interest rates rise. So those rising cash flow [expectations] can offset the impact of rising interest rates, where bonds don't have that luxury.

So, usually … stocks that tend to be more volatile or more sensitive to the business cycle tend to do a better when you have a rising-rate environment.

Stipp: Of course, stocks are not a monolithic set. There are different types of stocks. And we know for a long time, interest rates were so low that investors were really looking for income anywhere else [than bonds], especially dividend-paying stocks.

…Let's say I'm one of those investors who went into dividend payers, because rates were so low. How did my dividend stocks perform during this period that we saw rates rise?

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