Page 16 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY

Alternate Sources of Yield moved uniformly. On the contrary, short-term
yields have risen while long-term rates have
remained relatively unchanged. Today’s yield
James Camp, CFA, Managing Director of Fixed curve shape is a product of both the Fed’s
Income, Eagle Asset Management*, discusses the methodical short-term interest rate hikes and
difficulties facing dividends and his outlook on investor sentiment, which has held intermediate
and long-term rates in place. In addition,
future distributions. persistently low interest rates around the globe
have created steady demand for U.S. Treasuries,
which have relatively higher yields than most
sovereign debt from around the world. Along
Just as value stocks lagged growth stocks over the last with weaker global growth, geopolitical risk, a
couple of years, a similar trend can be seen between strengthening dollar, and low inflation, this has
income-producing stocks and the broader equity proven to be a strong headwind to higher
markets. Non-paying larger cap stocks outpaced intermediate and long-term interest rates.
dividend payers by over 10% in 2017. Moreover, within THE ECONOMIC CYCLE
the dividend-paying space, higher-paying dividend stocks Parts of a normal economic cycle include
experienced similar underperformance relative to their expansions and recessions. An inverted curve
lower-paying counterparts. signifies that shorter-term rates are higher than
longer-term rates. In recent history, inversions
While non dividend-paying stocks only make up 16% of S&P 500 have preceded recessions. Historically, equity
companies, they have provided an outsized portion of recent returns. markets have peaked after the start of an inverted
Conversely, returns on high-yielding dividend securities have turned curve. The prospect of a looming recession can
negative year-to-date, despite a recovery in July. Dividend-paying stocks incentivise investors to buy bonds with longer
are sensitive to rising interest rates, due in part to the higher amount of maturities as a safe-haven trade in the face of
debt typically carried by these companies. As rates rise, so does the cost falling equities and/or as a method of preserving
of servicing debt, ultimately dampening profits and placing pressure on capital, potentially causing a fall in long-term
stock prices. yields. Since bond prices rise as yields fall, falling
fixed income yields often lead to total return
Despite a challenging rate environment, dividends continue to grow and
reacceleration is occurring in many sectors, including financials, where gains. This inverse correlation allows high- quality
regulatory reform is freeing up capital for increased payouts. Income fixed income to potentially act as a balance to
investors would do well to remember that dividend-based strategies growth assets, such as equities.
adhere to an ‘objective-based’ approach, and, in that context, these It is important to keep in perspective that, on
strategies are meeting that objective by delivering income. average, periods of economic expansion have
been much longer than periods of recession, and
Going forward, headwinds in this space include a potential market
correction and rising interest rates, with higher-paying dividend stocks positively sloped curves persist much longer than
being the most sensitive to these events. More modest paying inverted curves. As a result, attempting to ‘time
companies, which yield slightly more than the S&P 500 as a whole, have the market’ based on the shape of the yield curve
historically provided the best risk/return characteristics. is an extremely difficult technique for fixed income
investors focused on total return. Since long-term
In the past 15 years, there have been nine periods when the 10-year planning is typically the norm, it is more of a
Treasury yield had a significant move (approximately 100 basis points or distraction for fixed income investors seeking
more). Modest-yielding stocks suffered only two periods of negative income and portfolio preservation strategies. Each
returns, while the S&P 500 High Yield Dividend Index fell in three of the last three recessions has given way to three
periods. The average returns during these periods for the two groups of the longest expansionary periods in recent
were 6.88% and 4.38%, respectively. history: March 1991, November 2001 and June
2009. Over the last 60 years, expansionary periods
Source: FactSet are, on average, roughly 5.5 times the length of
*An affiliate of Raymond James & Associates, Inc., and Raymond James Financial Services, Inc.

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