Investors Shun Dividend Stocks as Bond Rates Rise
At first blush, it looks as though investors have grown tired of dividend-paying stocks. Since the start of this month—when bond yields began to rise as a result of the stronger-than-expected economy—dividend-paying stocks have returned just 1.12 percent, according to Standard & Poor's. Meanwhile, stocks in the S&P 500 index that don't pay any dividends have gained 2.33 percent on average. This marks a reversal of fortune from the beginning of this year, when dividend-payers gained 2.10 percent in January and February, versus the 1.77-percent gain for the non dividend-payers.
So what happened? This turn of events might be explained by the recent jump in long-term bond yields. Since June began, the yield on 10-year treasury notes has jumped from 4.96 percent to as high as 5.32 percent. And as new bonds have begun to pay investors higher yields, interest among income-oriented investors has naturally shifted somewhat away from dividend-paying stocks to higher-yielding bonds. This would explain why utility stocks, which have historically been bought for the income they throw off, have been the market's worst performers over the past month.
Moreover, the reason behind the rise in bond yields may also have something to do with this recent trend. Typically, investors favor dividend-paying stocks "as economic growth is projected to decelerate," says Sam Stovall, chief investment strategist for S&P. That's because in a slowing economy, dividend-paying stocks literally pay investors to wait until the economy and business improve.
But the recent message of the bond market couldn't be any clearer: The economy is doing much better than investors assumed at the start of this year. In fact, U.S. gross domestic product, which expanded just 0.6 percent in the first quarter, is now expected to jump by 3 percent or more in the second. That's not deceleration — it's rapid acceleration. And during times of robust growth, investors often bet bigger on the potential capital appreciation of non dividend-paying shares versus the certainty of income in dividend-issuing stocks.
Still, many investors expect the market will come back around to the dividend payers. Why?
For starters, even though the economy is getting a second wind this year, it's clear that the current bull market is getting long in the tooth. And as bulls age, investors typically gravitate toward the dividend payers. "The current bull market started in early October 2002, and is now almost 57 months old," says Stovall. That's three months longer than the average bull has survived going back to World War II.
Moreover, while it's true that bond yields have risen lately, "they're still lower than they were a year ago," says S&P senior index analyst Howard Silverblatt. And yields on 10-year treasuries have started to give back some of their recent gains. This means investors may soon start to shift back into the dividend payers.
Also, keep in mind that the recent volatility in the bond market has fueled increased rockiness in the stock market. And eventually, the roller coaster ride in stocks is likely to drive investor focus back to more stable dividend-paying stocks, says Duncan Richardson, chief equity investment officer at Eaton Vance.
"What we need to see is a change in the risk-reward scenario," adds Silverblatt. In other words, once investors begin to appreciate the risk of investing again, they will naturally embrace safer dividend-paying stocks.
Finally, there's the long term to think about. And here, the advantage of dividend-paying stocks is crystal clear. Had you invested $10,000 in dividend-paying stocks in the S&P 500 at the end of 1979, your money would have grown to $443,524 today, according to S&P. However, had you invested that same $10,000 invested in only non dividend payers in the S&P 500, your investment would have grown to just $260,078.
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