In a low-interest rate environment, investors have naturally turned their attention to stocks paying high dividends as a way to generate income. Momentum, as a return factor, has not been in the spotlight. However, as interest rates have moved higher from their lows of last summer (On October 10, 2013 the 10-year US Treasury yield was 2.71% compared to 1.43% on July 25, 2012.), you might wonder how high dividend paying stocks tend to perform in rising rate environments over time. A current trend chart of the 10-year U.S. Treasury Yield Index, shows that yields are trending higher.
Source: Dorsey Wright
A longer-term chart of the 10-year US Treasury Yield Index is shown below:
Jim O’Shaughnessy’s What Works On Wall Street says this about high-yielders:
The high-yielders from Large Stocks do best in market environments in which value is outperforming growth, winning 74 percent of the time. They also do well in markets in which bonds are outperforming stocks, winning 65 percent of the time in those environments.
O’Shaughnessy’s book lays out the performance of portfolios formed by a number of return factors since the 1920s. His book includes the performance of portfolios formed by market capitalization, price-to-earnings ratios, EBITDA, price-to-cash flow ratios, price-to-sales ratios, price-to book ratios, dividend yields, relative strength (momentum), and many other factors.
In the rising interest rate environment of the 1960s and 1970s, O’Shaughessy shows the performance for the portfolio of the highest yielders as follows:
Source: What Works On Wall Street
Not bad—the dividend-focused portfolio was still able to generate modest outperformance. However, a portfolio formed by price momentum was clearly able to generate much higher returns in a rising rate environment. While this may not be the best environment for portfolios of high dividend payers to really stand out, investors may find that momentum can excel in rising-rate periods.
Past performance is no guarantee of future returns.