Interest rates were bound to rise eventually – but the timing of such things always seem to jolt investors when they materialize. On May 1st the 10 year U.S. Treasury Note hit its low yield of the year at 1.61% – only to rise 81% – hitting a recent peak of 2.92% on the 22nd of August. Bond prices of course move inversely to yield, so this back up in rates has taken a toll on the average bond investor’s portfolio. The stock market’s impact has been much more muted to this point, but it got us thinking again about the relationship between stocks – specifically dividend paying stocks – and the rest of the stock market should interest rates continue to climb. The common belief is above-average yielding stocks will suffer in rising rate trends, but historical results tell us otherwise.
Looking at the last half century of data ending in 2010, we analyzed stock market returns in periods when interest rates trended higher. This is a simple and straight forward evaluation – but we agree with Peter Lynch who once said “never invest in any idea you can’t illustrate with a crayon” – and believe the same stands true for parameters in research. Over the last 50 years we defined any rising rate trend as two consecutive years when the yield on the 10 year U.S. Treasury Note increased. Any serious investor should have funds invested for at least this amount of time so it’s certainly not too long an evaluation frame, and it’s also short enough to get multiple samples. There were 13 episodes of rising rate trends under this definition, more than half in the inflationary period between 1974 and 1982. Breaking down the stock market into two buckets, high dividend payers were defined as the top 30% of the S&P500 stocks in dividend yield terms in each calendar year, and then compared to the S&P500 as a whole. The total return for holding 10 year U.S. Treasury Notes during those periods was also examined. Below are the results.
Over half of a century, rising interest rate trends were not a reason to avoid high dividend paying stocks versus the ‘average’ stock. In fact, the opposite is true. The real truth is that the power of income generation from equities through higher than average, growing dividends, is paramount – despite the perceived headwind of rising rates.
Sources: Martin Capital Partners, LLC, Federal Reserve Bank of St. Louis, Fama & French.