by It should surprise no one that one of the best performing investment strategies over the past 15 years has been to play defense, specifically by buying high-dividend paying stocks in sectors like consumer staples, health care, and utilities. Not only have those stocks proven less volatile than the broader market, they have drawn increasing investor interest as interest rates have remained stubbornly low. But as rates look set to increase at least in some parts of the world, Marc Häfliger, Michael O’Sullivan, and Robert Cronin of Credit Suisse’s Private Banking & Wealth Management division (PBWM) decided to investigate whether the strategy still holds promise today. The answer: It depends where you’re talking about. For European investors, defensive equities are still the best way to gain dividend exposure. But in the U.S. and U.K., where economic recoveries are more advanced and monetary policy is due to tighten sooner rather than later, investors are better off switching into dividend-paying cyclical stocks. It’s been a good run, that’s for sure. In both the U.S. and U.K., interest rates have decreased gradually and significantly since 1981, when the Fed Funds rate briefly hit 20 percent in the United States and the official bank rate topped 15 percent in the U.K. As government bond yields slowly declined, income-seeking investors increasingly turned to dividend stocks.
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Ashley Kindergan considers the following as important: Investing: Features
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It should surprise no one that one of the best performing investment strategies over the past 15 years has been to play defense, specifically by buying high-dividend paying stocks in sectors like consumer staples, health care, and utilities. Not only have those stocks proven less volatile than the broader market, they have drawn increasing investor interest as interest rates have remained stubbornly low. But as rates look set to increase at least in some parts of the world, Marc Häfliger, Michael O’Sullivan, and Robert Cronin of Credit Suisse’s Private Banking & Wealth Management division (PBWM) decided to investigate whether the strategy still holds promise today. The answer: It depends where you’re talking about. For European investors, defensive equities are still the best way to gain dividend exposure. But in the U.S. and U.K., where economic recoveries are more advanced and monetary policy is due to tighten sooner rather than later, investors are better off switching into dividend-paying cyclical stocks.
It’s been a good run, that’s for sure. In both the U.S. and U.K., interest rates have decreased gradually and significantly since 1981, when the Fed Funds rate briefly hit 20 percent in the United States and the official bank rate topped 15 percent in the U.K. As government bond yields slowly declined, income-seeking investors increasingly turned to dividend stocks. They also sought them because of fear, the kind that arises as a result of two significant bear markets in just 15 years. Global equities fell 48.8 percent in the dot-com crash of the early 2000s and 57.5 percent in 2008. Losses of that magnitude create consternation about companies yoked too tightly to the business cycle.
Solve one problem, though, and you’ve got another—and in 2015, neither of the above solutions seems so workable anymore. For one, defensive equities tend to underperform in a rising rate environment. Both the Federal Reserve and the Bank of England are poised to raise benchmark interest rates in the next six months, which will reduce the yield differential between bonds and dividend stocks. What’s more, that flight to safety has made safety expensive. In the U.S., in particular, valuations for defensive stocks have risen in each of the last three years, while those of cyclical stocks have fallen.
The environment in Europe, where the central bank is likely to continue its quantitative easing program well into 2016, is much more supportive. The difference between dividend yields and sovereign bond yields there is 3 percent, compared to 0.4 percent in the U.S. On the valuation front, the premium of high-dividend stocks to the broader market is at its lowest level since 2012. Investors have recently been funneling money into high-dividend European equities funds at twice the rate they have into broader market funds, and they should continue to do so as long as rates remain low.
In short, the dividend-seeking investor in the U.S. or U.K. needs to rethink their approach, and Credit Suisse’s PBWM thinks it’s time to move out of defensive sectors and into more cyclical ones. But in Europe, they can stick to the status quo.