By now, you’ve probably heard that interest rates will rise sometime this year, with the only unknown being “which month?” Usually, such news is accompanied by advice from market pundits saying that high-dividend stocks such as utilities would lose value when interest rates rise.
Since I’m the proprietor of the Dividend Detective website, verifying that premise is of more than passing interest to me.
So, what has happened to dividend stocks in past years when interest rates rose? To find out, I picked six representative high-dividend stocks and tracked their share price and dividend levels over the 16 years ranging from January 1, 1999 to January 1, 2015.
I picked that timeframe because it covers two major interest rate spikes. Using the 12-Month LIBOR (London Interbank Offered Rate) as a gauge, rates spiked from a low of about 4% to a high of 7.5% in 2000, and from around 1.4% to 5.7% in 2006.
My findings were surprising, at least to those espousing the conventional wisdom.
For example, I analyzed two Real Estate Investment Trusts (REITs) that own commercial properties; office building owner Vornado Realty Trust (VNO) and shopping center owner Simon Property Group Inc ($SPG). Because REITs don’t pay federal income taxes if they pay out at least 90% of income to shareholders, they are typically high-dividend payers.
A Series of Fortunate (and Profitable) Events
So, what happened? Both Vornado and Simon enjoyed higher earnings and increased their dividends after interest rates rose in 2000 and again in 2006. Here’s why:
Interest rates rise when the economy is strengthening, and when the economy picks up; property owners can raise rents, driving earnings, and hence, pushing share prices higher. Further, according to the rules governing REITs, higher earnings must translate to higher dividends.
Conversely, when the Fed forces interest rates down to battle a weakening economy; falling rents and higher vacancies cut property REIT earnings, triggering dividend cuts and share price drops.
However, recent history presents an exception. Since 2009, interest rates have generally dropped while the economy has strengthened. Over that timeframe, reflecting improving business conditions, both Vornado’s and Simon’s share prices and dividends rose. Thus, for property REITs, share prices and dividends were mainly driven by business conditions, not interest rates.
You don’t have to take my word for any of this. You can view charts comparing LIBOR rates to share prices and dividend payouts for each of the six stocks mentioned in this column at dividenddetective.com/rates.
What About Utilities?
I checked two of the largest, Southern Co (SO) and Dominion Resources, Inc. (D) . Both offer electric and natural gas utility services in numerous states. Similar to the property REITs, both Dominion and Southern shareholders enjoyed rising share prices and dividend hikes when interest rates rose. Why? Utilities prosper in a strengthening economy because their customers are using more natural gas and electricity.
Mortgage REITs Drop When Interest Rates Rise
Finally, the third category of stocks that I checked were mortgage REITs. Unlike property owners Vornado Realty and Simon Property, mortgage REITs invest in mortgages and other loans that are secured by real estate. They profit by investing funds borrowed at relatively low short-term rates in mortgages that pay higher long term rates. Analyzing mortgage REITs Annaly Capital Management, Inc. (NLY) and MFA Financial, Inc. Real Estate Trust (MFA) , I found that unlike property REITs, when interest rates rose, mortgage REIT earnings and dividends consistently dropped, and vice versa.
One reason might be that rising interest rates reduce the value of a mortgage REIT’s mortgage portfolio, forcing the REITs to write-down the value of their assets, cutting earnings, and hence, dividends. Based on my admittedly skimpy study, only mortgage REIT investors are likely to suffer when interest rates rise. Property REIT and utility stocks should enjoy a good run.
Did I cherry pick these examples to prove my preconceived ideas? Nope. My main problem was finding stocks trading since 1999 to use as examples, especially for mortgage and property REITs, but not so much for utilities.
From my list of available examples, I eliminated stocks influenced by company specific events such as mergers and acquisitions, and then I picked the biggest players from the remaining candidates. Since stocks in the same business sectors tend to trade together, I’m confident that checking additional examples would not change the conclusions.
For tips and information on the best utilities and dividend stocks from Harry Domash, please check out Dividend Detective.
DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer