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Why stocks paying juicy dividends could make a comeback this year

Jan 17, 2024 Finance

Shares of companies that offer steady payments could be back in the good graces of investors this year.

Dividend stocks fell out of favor in 2023, even as all three major US indexes overcame regional banking turmoil, high interest rates and geopolitical tensions to notch double-digit returns.

As interest rates rose to a 22-year high, investors favored bonds at attractive yields over riskier stocks offering smaller payouts. Artificial intelligence hype also drove investors into mega-cap tech stocks, while the rest of the market lagged behind.

The S&P 500 Dividend Aristocrats index, which measures the performance of companies that have increased their dividend payments in each of the last 25 years, rose 5.7% last year compared to the S&P 500 total return index’s 26% gain.

That was a reversal from 2022, when the dividend index outperformed the benchmark total return index as investors fearful of the Federal Reserve’s interest rate hikes sought income-paying stock havens.

 

Some traders believe that dividend stocks could make a comeback this year. Yields swooned in late 2023 and could continue ticking lower if the Fed cuts interest rates.

“Investors are seeking durable, higher yielding dividends as market volatility is expected to continue throughout the easing cycle,” wrote Morgan Stanley strategists in a Monday note.

Larry Adam, chief investment officer at Raymond James, favors dividend stocks in sectors like tech and healthcare for their growth qualities, over traditionally defensive categories like utilities. His firm only invests in dividend stocks that have that growth component, he says.

“We look for not only good valuations, but the ability to keep it up,” said Adam.

Investors tend to reward companies when they raise their dividends. Lennar shares are up more than 6% this week after the home construction firm on Tuesday hiked its annual dividend to $2 per share from $1.50 and raised share buybacks by $5 billion.

Mastercard on Dec. 5 said that its board had approved raising its quarterly dividend to 66 cents a share from 57 cents and a new share repurchase plan up to $11 billion. Shares of Mastercard have since gained about 5%.

Companies in the Russell 1000 index that raised their dividends saw their stock prices outperform by 3.1% on average in the six months following the announcement of the increase, according to Morgan Stanley data going back to 2014. Those that lowered their dividends saw their stock prices underperform by 4.7% during that same period.

Of course, bond yields are unlikely to see a smooth decline. Yields edged up to start the month, helping send stocks lower, and the market could continue seeing some volatility this year as investors recalibrate their rate expectations.

Wall Street currently expects the Fed to cut rates seven times this year, according to the CME FedWatch Tool, while the central bank has only penciled in three cuts.

Getting inflation to exactly 2% will be tough

The Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures price index, measured 2.6% annually in November. So, getting that number down to the Fed’s 2% target should happen in no time, right?

It might not be that simple, reports my colleague Elisabeth Buchwald.

Fed officials predict it will take two more years to get to a firm 2%, according to the Fed’s latest Summary of Economic Projections.

In many ways, it was easy to get inflation down from its peak. In fact, many economists say it may not have even been necessary to raise interest rates to the highest level in 22 years in order to achieve that goal. That’s because much of the run-up in inflation came from pandemic-induced supply chain disruptions and unusual spikes in demand.

“If you print up $3 trillion of new money and give it to people, you get inflation, and that’s pretty much what happened,” said John Cochrane, a senior fellow at the Hoover Institute. “But once that money is spent, inflation slows down on its own, which is also pretty much what happened.”

Mortgage rates rise for second straight week to 6.66%

Mortgage rates ticked up this week for the second week in a row, but remain more than a full percentage point lower than their high last year, reports my colleague Anna Bahney.

The 30-year fixed-rate mortgage averaged 6.66% in the week ending January 11, up from 6.62% the previous week, according to data from Freddie Mac released Thursday. A year ago, the average 30-year fixed-rate was 6.33%.

Even with the past two week’s increases, mortgage rates are making smaller moves than during the nine-week drop at the end of 2023 and are still more than a full percentage point lower than their highest levels of last year: 7.79%. This continues to bring improved affordability for homebuyers who’ve been struggling in one of the least affordable markets in decades.

“Mortgage rates have not moved materially over the last three weeks and remain in the mid-six percent range, which has marginally increased homebuyer demand,” said Sam Khater, Freddie Mac’s chief economist, in a statement.

But, he added, even this slight uptick in demand, combined with inventory that remains tight, continues to cause prices to rise faster than incomes.

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