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By Josh Peters, CFA and Jeremy Glaser | 09-18-2014 11:00 AM

4 Dividend Payers for a Higher-Rate World

Trying to time interest-rate increases is less important than choosing companies with a good margin of safety that you can hold through thick and thin, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Even though the Fed said they're going to keep rates low for a considerable time, investors are preparing for a potential increase in rates. I'm here with Josh Peters--he's editor of Morningstar DividendInvestor newsletter and also our director of equity income strategy--to talk about what impact that could have on dividend-paying equities.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Now, I know you don't provide any kind of forecast on what's going to happen--

Peters: No, no, no, no, no, no, no ...

Glaser: But I do have to ask, generally, what's your take on how the Fed is handling the situation right now? Do you have a rough timeline of when we could see short-term rates start to tick up?

Peters: I really do not. I try to avoid like the plague making specific macro predictions, especially with a specific timeframe in mind. First of all, I have a terrible record. I bought my first house in April of 2007. I almost top-ticked the Chicago housing market. I proved to everybody's satisfaction that I can't time these things.

But on the other hand, I think what you need are planning assumptions, as opposed to a forecast. And one of the basic planning assumptions that you should have as an investor, especially with higher-yield equities, is that interest rates are going to go higher over the long term. There's just not that much room for them to drop. And the farther out you look, if you assume that the economy continues to heal and that eventually things get back to what we would think of as normal, then that probably correlates to a 10-year Treasury rate not in the 2s or even the 3s but maybe in the 4s. It's not a specific forecast, but the way I use it is to say, "Here is the basic direction we're going in and I don't want to pay a valuation for, say, an interest-rate sensitive stock that is inconsistent with a 4% to 5% long-term Treasury rate."

If I am, then once that happens--if it happens--then I'm going to suffer a valuation contraction and possibly a loss of capital. So, that's what I want to avoid.

Glaser: Dividend-paying stocks are often seen as very interest-rate sensitive. Do you see it that way? Do you expect to see a big crunch if we do get into that 4% to 5% range?

Peters: That's a time-horizon question. When we get to that day or week, you could see a big sell-off. You could see a big sell-off in this segment of the market or any segment of the market, really, for any reason. I don't think there is any point really trying to control for that.

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