Why High Dividend Stocks May Make Sense Amid Bond Volatility

The Federal Reserve’s first rate hike in years has sparked bond volatility, pushing investors to search for yield elsewhere. Michael Hunstad, head of quantitative strategies at Northern Trust examines how high dividend strategies appear to be a good alternative:

Rising interest rates and difficult fixed income markets have prompted many investors to seek additional yield from their equity portfolios. Investing in high dividend strategies may help manage portfolio risk amid rising interest rates and inflation, as dividend stocks are attractively priced in the outlook for dividend growth is improving. Let’s take a closer look. The recent rate hike by the Federal Reserve, the first since 2018, sparked significant volatility in the bond market. This has given investors pause, leading them to source income elsewhere.

In each of the last five interest rate hike cycles, dividend stocks outperform the broad market by an average of more than 12% over the cycle. Historically, dividend stocks have also done well in both high and increasing inflation environments. And this cycle is no different. With rising rates and higher inflation, dividend strategies have had a strong outperformance in 2021 and year to date. Despite this strong performance, dividend stocks remain relatively inexpensive with average price to earnings multiples of about 17 versus the equity market average of about 23. The recent surge in corporate earnings and profits have improved both dividend coverage and the capacity to grow dividends. The payout ratio or the percentage of earnings used to pay dividends is less than 30% versus the long-term average of 35%. So there’s a significant upside to project dividends per share should payout ratios revert to the average.

Well-designed dividend oriented strategies can deliver 2% to 4% yield, similar to or greater than many government and corporate bonds. With embedded hedges against rising rates and inflation, low multiples, and strong yield growth potential, dividend strategies are a worthwhile income play to consider in today’s market environment.