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January 2024



Equity Income:
Positioned for a Pause





Tony Hu Director

Key Points

  • Important dividend sectors historically outperform when interest rates decline.
  • Key sectors, like Utilities, Staples and Telecom, are trading at levels near historic lows.
  • As with its key sectors, we see dividend stocks as attractively valued.

The sharp market rally that closed out 2023 resulted from economic data and Fed rhetoric that moved forward expectations for the timing of the Fed beginning to cut interest rates. This anticipation led to a steep decline in interest rates up and down the curve. For dividend stocks, even the pause before a cutting cycle represents the alleviation of a headwind (rising rates) ahead of a potential transition to a tailwind (declining rates). And if we look a little beneath the hood, examining some key sectors, we can see that what is true for the dividend universe as a whole (e.g., attractive relative valuation, outsized near-term performance gaps) is true for important components as well.  

Utilities, Staples, and Telecom stocks, which are among the most income-oriented and defensive, account for about 40% of our dividend universe. They are quite important to how our universe performs, if not determinative. And as Chart 1 shows, their historic relative performance vs. the broader market tends to trade inversely with the direction of 10-year rates. During the peak-to-trough in periods when rates have been rising, the median relative drawdown was -17%. Conversely, when rates have stopped rising, and when they are on a path to decline, median outperformance was of a similar magnitude.  

Chart 1: Defensive Income Sectors/S&P 500 vs. US 10Y Yield (inverted)

Source: Factset, as of 12/31/23.

Past performance is no guarantee of future results.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Rates are not all that is in play in relative performance. But they do have a meaningful impact. Likewise, we have previously explored the valuation gaps between dividend stocks and the broader market, which remain near multi-decade highs. Charts 2 and 3 show that the defensive income sectors we have been discussing are trading at relative valuations near the bottom of their long-term ranges — at levels from which we have previously seen strong bouncebacks.


Chart 2: Fwd P/E Staples vs. S&P 500

Source: Factset, as of 12/31/23.

Chart 3: Fwd P/E Utilities vs. S&P 500

Source: Factset, as of 12/31/23.

 

For illustrative purposes only. Securities shown are not to be viewed as investment recommendations.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses. Information is subject to change and is not a guarantee of future results.

Information is subject to change and is not a guarantee of future results. 

Utilities Select Sector SPDR ETF Fund - The Fund is an ETF that trades on the US Stock exchange and seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Utilities Select Sector Index. The Fund has a gross expense ratio of .10%.

Consumer Staples Select Sector SPDR ETF Fund - The Fund is an ETF that trades on the US Stock exchange and seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Consumer Staples Select Sector Index. The Fund has a gross expense ratio of .10%.

 

Whether the economy has a soft landing, or even enters recession, is an unknown, but we believe that the dividend universe is well positioned for the balance of factors that we are watching in 2024.

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