By: Dividend Sensei
Since Donald Trump’s surprise election victory on Nov 8th, bonds have taken a pounding and long-term US interest rates have soared about 0.6%. This has brutalized some favorite dividend industries such as REITs, Utilities, consumer defensive giants, and MLPs. Let’s take a look at why this is happening, what the future is likely to hold, and what it means for your portfolio.
Why interest rates are rising
Ultimately long-term interest rates are set by the market’s expectations of what inflation will do in the coming years. For the past eight years weak economic growth, copious amounts of central bank bond buying, and low inflation expectations have resulted in the lowest interest rates in history. This has hurt savers, and risk averse investors such as insurance companies, and pension funds, which count of earning solid risk free returns on things like US Treasury bonds.
The desperate search for yield has forced many investors to turn to stocks, such as MLPs, REITs, utilities, and consumer defensive names such as Johnson & Johnson, Procter & Gamble, and Coca-Cola to provide income. This has resulted in their prices appreciating to near bubble levels, and resulted in their yields falling to historical lows.
However, now things are finally starting to change. Over the past few months economic data seems to be indicating that US economic growth is starting to strengthen. In addition, the incoming Trump administration has promised stimulus in the form of infrastructure spending, and tax cuts which should boost economic growth further. Economic growth, combined with greater borrowing by the government has stoked inflation concerns and so interest rates are rising.
Today 10 year and 30 year Treasuries yield about 2.4% and 3.1%, which while not high by any measure, is a lot better than the 1.36% all time low 10 Year yields hit in the wake of the Brexit vote.
Combine this long-term rate growth with the Fed’s continuing promise to raise short-term rates steadily as long as the economy can bear it, and you can see why things like REITs, and Utilities have been kicked in the teeth.
Why our favorite dividend stocks are falling
REITs, MLPs, and Utilities are capital intensive, meaning that it takes a lot of debt to run and grow these businesses. Higher rates means that rolling over their long-term debt will likely occur at higher interest rates, which will put pressure on profits going forward.
On top of that, if US Treasuries offer risk free rates of 3% then investors no longer have to own overpriced dividend blue chips like JNJ to get their income needs met. In other words, the yield risk premium that investors will demand to own riskier stocks, even blue chips, is likely to put downward pressure on share prices. This is why stocks like Coca-Cola are trading at 52 week lows. The reversal of desperate yield starved capital out of things like REITs, utilities, MLPs, and consumer defensive stocks has resulted in the kinds of painful, but necessary corrections that we’ve seen across the market.
Here’s what to do now
Is now the time to sell all REITs, utilities, MLPs, and dividend stocks? Of course not. Rather use the corrections in these sectors as buying opportunities. After all, the markets tend to overreact in both positive, and negative directions.
That means that REITs, which were overvalued on August 1st, are now starting to look cheap. Meanwhile quality midstream MLPs such as EPD, HEP, and MMP never recovered from the oil crash and are still buys today. Similarly with utilities, you can now get much nicer prices for some solid picks like D, NEE, WEC, WTR, and AWK.
Remember that the market is always offering things on sale, and rather than try to play a losing game by trying to time the tops and bottoms of various sectors, you can’t go wrong in the long-term if you just invest in whatever is cheap at the moment. Focus on the fundamentals: buy quality, dividend growth stocks for the long-term, add on dips, reinvest the dividends, and over 10 to 20 years or more, you are pretty much guaranteed to wind up wealthier than you probably thought possible.