Leveraging Dividend Growth for Rising Rates Protection

Seasoned advisors know that there plenty of occasions when solving common problems – namely rising interest rates – is best accomplished with prosaic, not-so-exotic solutions.

The imminent Federal Reserve tightening cycle hasn't even started, but it's already proving vexing for fixed income investors. However, the Fed's upcoming rate hikes won't require advisors to stretch into unfamiliar territory to provide clients with proper guidance. Some basic asset classes will do just fine. Perhaps better than fine.

Enter dividend stocks, particularly the growers. This isn't a recommendation for advisors to follow the heard, but data confirm that in the early stages of 2022, market participants are fleeing fixed income funds and embracing dividend fare.

“U.S. investors are snapping up funds that invest in dividend-paying stocks as they search for stable income from alternatives to bond markets, which are being roiled by the prospect of rate rises.

According to Refinitiv Lipper, investors bought $6.9 billion in U.S. dividend funds in January, the highest net purchases since October 2006,” reports Patturaja Murugaboopathy for Reuters.

Compare that with the $20 billion that was yanked from bond funds last month.

History Matters

As is often noted in this space, past performance isn't a guarantee of future returns, but some historical trends are meaningful. Those include the performance of value stocks, which often include plenty of dividend payers and growers, in rising rate environments.

“High-yield strategies tend to lean to the value side of the style box, and value stocks have generally held up better than growth stocks during the current bout of volatility. Their higher income levels are also attractive relative to other options,” says Kieran Kirwan, ProShares senior investment strategist.

As Kirwan points out, history matters. Advisors probably know this, but many clients don't and this is a significant value-add opportunity. Rising rates aren't a death knell for stocks. In fact, history confirms the opposite is true.

“As usual, history often can provide much-needed context. We offer two points to consider. First, perhaps the most obvious is that rising rates alone don’t have to signal weak returns for equities,” says the ProShares strategist. “Despite negative returns in January, equities can and have performed well in prior periods of rising rates. Over the past two decades, the S&P 500 has performed strongly during several sustained periods when rates increased.”

Add to that, dividend growth strategies are exceedingly relevant today for multiple reasons. First, as rates rise, so will bond yields. Management teams at dividend-paying companies know this and some are likely to continue boosting payouts in an effort to not risk losing investors to bonds. Second, dividend growth is an ideal avenue for beating inflation – obviously a relevant consideration in today's climate. And yes, history confirms as much, too.

Be Selective

Being choosy when it comes to dividend strategies is imperative as a means of coping with and coming out on top of inflation and Fed tightening.

“Dividend growth as a strategy, as represented by the S&P 500® Dividend Aristocrats® Index, has outperformed high dividend yielders during both falling and rising interest rate periods as defined by the DJ US Select Dividend Index,” concludes Kirwan. “The Aristocrats have also provided attractive dividend growth rates for years—an especially attractive feature as inflation continues to run at the highest rates we’ve seen in decades.”

Best of all, from mid-2005 through the end of 2021, the S&P 500 Dividend Aristocrats Index beat the DJ US Select Dividend Index regardless of whether rates were falling or rising.

Related: How to Avoid the Stocks Dogging this Market