How Will Rising Interest Rates Impact Dividend Stocks?
As the world awaited the new bailout bill, CNBC reported, “10-year Treasury yield hits highest level in a year”.
“The yield on the benchmark 10-year Treasury note climbed to 1.29% at around 4:15 p.m. ET, breaking above the 1.28% level for the first time since February 2020. Meanwhile, the yield on the 30-year Treasury bond rose to 2.08%.
…. The 10-year benchmark is widely watched as it influences mortgages and other loans.
Treasury yields were higher as investors continued to watch for progress on the proposed $1.9 trillion stimulus package in Congress.”
Bond prices go down when yields go up. How much can they rise before having a major negative effect on the bond market?
A week earlier, I was surprised to see ZeroHedge report, “Never Seen Anything Like This”: Junk Bond Yields Slide Below 4% For First Time Ever In Record Buying Spree:
“The average yield on US junk bonds just dropped below 4% for the first time ever as investors keep piling into an asset class historically known for its “high yields”, although if sub-4% is considered high then there is a problem.”
What are junk bonds?
Investopedia tells us:
“A junk bond is an investment in debt. A company or a government raises a sum of money by issuing IOUs stating the amount it is borrowing, the date it will return your money, and the interest rate it will pay….
Junk bonds have a lower credit rating than investment-grade bonds, and therefore have to offer higher interest rates to attract investors.
The rating indicates the likelihood that the bond issuer will default on the debt.”
We recently wrote about rising inflation. Buying bonds; when the interest rates do not beat inflation, is a guaranteed loser.
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A bigger concern
Last year, my wife Jo and I moved a good portion of our investments into dividend-paying stocks, with the help of Tim Plaehn, editor of The Dividend Hunter. Tim’s running a masterclass starting on April 1. You can check it out here.
We recently sold some of our common stock dividend payers with nice profits to reinvest in underpriced preferred stocks.
The CNBC article raised a yellow flag. I checked to see how our dividend payers are doing.
We currently own 12 of Tim’s recommendations. Some we’ve owned for a year or more, and some were bought in February 2021. All 12 are showing gains. In total, our gain is 12.8% (not annualized, but actual). The lowest current yield is 2.9%; however, that stock price appreciation is 21.4%. Some of the preferred stocks are yielding close to 10% based on our purchase price.
Terrific! …. But…interest rates are a factor in the pricing of dividend-paying stocks. Common stock prices may rise with inflation; while preferred shares are unlikely to rise much over par value.
I contacted Tim…
DENNIS: Tim, on behalf of our readers, thank you for your time. We are in the midst of yet another bailout package. Meanwhile, interest rates, inflation and the stock market continue to rise.
Chuck Butler recently explained the economy is sluggish.
Tim, I used an analogy you would like about what the instrument panel shows, versus what is really happening in the economy.
I’m hoping you can help us decipher things correctly and keep us on course.
My first question is – Tim, I know we are guessing, but do you see interest rates continuing to rise? With yet another huge bailout, the government is going to need to raise a couple trillion more.
TIM: Dennis, thanks for the opportunity to address your readers. I like your analogy about combining what the instruments are showing with instinct and good judgment.
Unless the rules of economics have been suspended, I think it is inevitable that we will see higher interest rates. The federal government is printing trillions of dollars, and that money will be looking for goods and services and places to be invested.
The result should be inflation, a booming stock market and higher interest rates. I expect rates to return to at least the pre-pandemic levels, and possibly much higher.
Against this rising tide stands the Federal Reserve. They can hold rates down by buying up most of the new debt issued by the government. Or at least they believe they can.
DENNIS: I’d like to discuss common and preferred stocks independently. I look at preferred stocks as a hybrid, a cross between a fixed income debt instrument, and a stock. What effect will interest rates, up or down, likely have on our preferred stock holdings?
TIM: Just like bonds, preferred stock market prices will fall if interest rates go high enough. However, our preferreds yield 6% to over 7%, so rates would need to go up much higher to materially affect share prices.
Even if preferred stock prices decline by a couple of dollars, the dividends will continue to be paid. The probability of a preferred being redeemed will be lower, since the issuer would have to issue debt to redeem a preferred stock.
The preferred dividends can continue indefinitely, providing a steady income, no matter what is happening in the stock market.
Should preferred stocks drop below par value it could signal an excellent buying opportunity. It depends on the individual company so they must be looked at independently.
DENNIS: Would your answer be any different if I had said common stocks?
TIM: If interest rates are rising, common stock share values and dividends will depend on the businesses of the individual companies. Higher interest rates will lead to higher profits for lenders such as banks and business development companies (BDCs).
Other types of companies will suffer. For example, the highly leveraged agency Mortgage backs securities Real Estate Investment Trusts (MBS REITs) will have to deal with falling prices in their bond portfolios. Any company that is highly leveraged could be squeezed if they cannot increase the cost of their goods or services as fast as the debt servicing costs grow.
DENNIS: If interest rates continue to rise and bond prices drop, might that help the dividend-paying stocks? I wonder how much investment capital would go toward higher interest-paying bonds versus stocks.
TIM: Higher interest rates may change, either positively or negatively, the business prospects of individual companies. Income-focused investors may need to pivot out of some income investments into others that will thrive with higher interest rates.
Investors need to watch for opportunities, if the market drives down the share prices of quality dividend investments, it will be time to load up and lock in some great yields.
I would avoid generalization and investing in a lot of funds – each company must be judged on their own merits.
|“In the midst of chaos, there is also opportunity.”
— Sun-Tzu, The Art of War
DENNIS: Back in my Casey Research days, my analysts preached about negative correlation (one zigs, the other zags) and non-correlated assets.
If something goes down, other profit opportunities may pop up.
Should interest rates continue to rise, where should investors look for profit opportunities?
TIM: Higher rates will be great for profits at financial companies including banks, Business development companies (BDCs) as mentioned above, and life insurance companies.
If the higher rates are accompanied by inflation, look to commodity-based stocks and investments, such as energy companies and gold miner stocks.
DENNIS: In our recent webinar, you remarked that you felt a dividend newsletter might eventually become boring. It became quite the opposite, as staying on top of things, changes in companies, markets and government impact are constant.
I read today where tax hikes are on the table which will affect all investors. How are you, and your readers, keeping up to date?
TIM: You ask a good question. My subscribers are very concerned and also asking for help. The issues you raised will be covered on our upcoming masterclass. It is a constant moving target; lately I’ve been burning the midnight oil in preparation.
DENNIS: Wow! I’d love for our readers to be able to participate.
TIM: Many of your readers are currently subscribers and will receive notification directly from us. Readers can also can check out this short video.
DENNIS: Jo and I plan on attending the class. We are all trying to find and hit moving targets. Tim, thanks again for your time.
TIM: My pleasure Dennis.
Dennis here. Tim has been gracious with his time and many readers have written in thanking him. Dividend payers are one of the few safe, income producing opportunities left; I can understand why he is very busy.
Chuck Butler explains things are going to get more complicated:
“The $1.9 Trillion in new deficit spending was passed at the end of the week, and before the President’s signature in ink, dried, there was talk of a $3 Trillion infrastructure Bill that’s coming…
Oh, sure, why just $3 Trillion? Why not make it $5 Trillion or $10 Trillion? It’s just money, and contrary to what my mother always preached to me… Money does grow on a tree… The Magic Money Tree… And don’t worry about how it will be financed, because the Fed is the buyer of last resort… I can’t begin to tell you just how wrong this type of thinking is…”
Things are changing quickly, and we are all in this together. Tim, Chuck and I are doing our best to stay on top of things as we are in uncharted waters. Stay tuned!
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On The Lighter Side
We are in Indiana pet setting this week. It took a week before we saw the sun. Eventually it broke through the clouds and spring is in the air. Soon everything will turn green.
I want to share some more photos of our drive across the country.
When we hit Flagstaff, we headed east on I-40.
The views as you head toward the continental divide are spectacular.
The second photo is one example of the scenery. The road on the right is old Route 66 which we paralleled all the way to Oklahoma City, where it turns northeast toward St. Louis and Chicago.
Once you move from New Mexico to Texas, we hit the plains and the scenery changes dramatically; with their own kind of natural beauty.
I’m with Kate Smith, “God Bless America”…
Quote of the Week…
“Life is about accepting the challenges along the way, choosing to keep moving forward, and savoring the journey.”
— Roy T. Bennett, The Light in the Heart
This week’s humor, “adult truths”, is supplied by Bob O.
- How are you supposed to fold a fitted sheet?
- Map Quest or Google Maps really need to start their directions on # 5. I’m pretty sure I know how to get out of my neighborhood.
- How many times is it appropriate to say “What?” before you just nod and smile because you still didn’t hear or understand a word they said?
- I have a hard time deciphering the fine line between boredom and hunger.
- I think the freezer deserves a light as well.
- I can’t remember the last time I wasn’t at least kind of tired.
And my favorite:
- I totally take back all those times I didn’t want to nap when I was younger.
Until next time…
“Economic independence is the foundation of the only sort of freedom worth a damn.” – H. L. Mencken
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