Is the High-Dividend Trade Over?


U.S. stocks finished in positive territory on the first trading day of the month of June, as the rose 0.6%, while the narrower, price-weighted gained 0.9%.

Such gains would normally coincide with a fall in the , Wall Street's fear gauge, but the index was essentially unchanged on the day, closing at 16.28. Perhaps option traders were accounting for the S&P 500's swings in and out of positive territory today. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

As the Federal Reserve and other major central banks crushed short- and long-term interest rates in the wake of the financial crisis, rendering government bonds and cash unattractive, investors piled into assets that could provide them with some incremental income. High-dividend-yield shares were one of the main beneficiaries of these flows; however, that trade may now be coming to an end.

Let me enter into the evidence the following graph, which shows the price performance, beginning on April 1, of three sectors offering among the highest dividend yields in the market:

  • Utilities (Dow Jones Utility Average, blue line)

  • Telecommunication companies (AMEX Telecom Index, orange line.)

  • Master Limited Partnerships, or MLPs (Alerian MLP Index, red line)

^DJU Chart
^DJU Chart

^DJU data by YCharts

The underperformance, relative to the S&P 500, is apparent, but it's nothing compared with that of another group of high-yielding shares, mortgage REITs, the largest of which -- and -- are down 14.8% and 22.5% over the same period.

What's going on with the "income trade" that was heretofore successful? Why are these stocks underperforming? The answer lies with investors' changing interest-rate expectations. Over the past couple of months, the market has come to believe that the Fed will curtail its quantitative easing (bond-buying) program and raise interest rates earlier than previously anticipated. Witness the 10-year Treasury yield, which shot up from 1.63% to 2.16% last month. As interest rates normalize, the premium investors are willing to pay for income-producing shares will fall. If it provides further evidence of a pick-up in economic activity, Friday's U.S. employment report could put another nail in the dividend income trade.

There's no question Annaly Capital's double-digit dividend is eye-catching. But can investors count on seeing that payout stick around? With the Federal Reserve keeping interest rates at historically low levels, Annaly has had to scramble to defend its bottom line. In The Motley Fool's premium research report on Annaly, senior analysts Ilan Moscovitz and Matt Koppenheffer uncover the key challenges the company faces and divulge three reasons investors may consider buying it. Simply click here now to claim your copy today!

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