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HomeMarketIn a Choppy Market, Stick With Quality Dividend Stocks

In a Choppy Market, Stick With Quality Dividend Stocks

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Dividend stocks are poised to notch an impressive victory this year. The
Dow Jones U.S. Select Dividend
index is ahead 5.5%, cruising past the
S&P 500
index, down 14.4% in total returns. Even more impressive, dividend stocks have left the tech-heavy
Nasdaq Composite Index,
down 26.7%, in the dust.

The disparity isn’t likely to last, as these performance trends tend to even out or reverse—growth could make a comeback, pulling up tech and other sectors not known for big dividends. But some analysts expect dividend stocks to keep powering ahead, betting that investors will favor their defensive qualities amid a potential recession and other market headwinds.

“Dividends are a defensive strategy in a choppy market,” says Chris Senyek, chief investment strategist at Wolfe Research. “In a volatile environment, where recession risk looms, investors are going to continue to pile into these stocks.”

In theory, macro conditions shouldn’t have been this buoyant to dividend stocks. Rising bond yields have been a headwind for all stocks this year as the Federal Reserve has raised interest rates. But higher rates were thought to be especially tough on dividend payers by making bonds more attractive for income investors. Why take chances with a stock yielding 3%, for instance, when you could buy a six-month Treasury bill at 4.7%?

But Dan Lefkovitz, a strategist at Morningstar Indexes, points out that there’s a weak link between dividend stocks and interest-rate movements.

Dividend stocks outperformed the market from 2004 through 2006, a period of Fed rate increases. And while dividend stocks didn’t outperform from 2016 to 2018, another period of rate hikes, they weren’t far behind. The Morningstar Dividend Yield Focus Index had a cumulative return, including dividends, of 27.8% from 2016 through 2018, slightly behind the 29.7% result for the Morningstar US Market Index.

Returns for dividend payers were even more impressive, considering that 2016-18 was “the height of the FANG market,” says Levkovitz, referring to a huge run-up for
Meta Platforms
(ticker: META), owner of Facebook;
Apple
(APPL);
Netflix
(NFLX); and
Alphabet
(GOOGL), parent of Google.

Company / Ticker Dividend Yield YTD Return Market Value (bil)
Exxon Mobil / XOM 3.3% 87.8% $455.2
Chevron / CVX 3.1 59.8 350.0
Cardinal Health / CAH 2.5 56.7 20.6
Archer-Daniels-Midland / ADM 1.7 45.4 53.0
Genuine Parts / GPC 2.0 31.3 25.5

Note: Data as of Nov. 29

Source: FactSet

The connection between rates and dividend stocks has been shaky in other periods, too. In the late-1990s, the Fed cut rates following a financial crisis in Asia, but dividend stocks lagged. “The market in the late-’90s didn’t want dividends, and it didn’t want earnings,” says Lefkovitz, noting that it was the dot-com bubble era.

Dividend stocks also underperformed in the late 1970s and early 1980s when the Fed boosted short-term rates well into the double digits.

Heading into 2023, Senyek expects dividend strategies to outperform in a “slow-growth or recessionary-type environment.” One of his favorite plays is the
S&P 500 Dividend Aristocrats Index,
a basket of 64 companies that have paid higher dividends for at least 25 consecutive years. “We prefer to fish in ponds of consistent dividend growth,” Senyek says.

The
ProShares S&P 500 Dividend Aristocrats
exchange-traded fund (NOBL) tracks the index. It’s down 4.3% this year, including dividends, a relatively strong showing against the S&P 500. Senyek calls the Aristocrats “still modestly cheap relative to their pre-2020 valuations.”

Some of the strongest Aristocrats have included
Exxon Mobil
(XOM), which has notched a total return of 87.8% this year, including dividends, with a 3.3% yield.
Coca-Cola
(KO), with a yield of 2.8% and a return of about 8%, has also been among the better-performing Aristocrats.

It’s important to note that not every dividend stock has made those kinds of gains. “If you look at this year’s market thematically, it very sector-driven,” says David Katz, chief investment officer at Matrix Asset Advisors, an asset management firm.

Of the S&P 500’s 11 sectors, only energy has delivered a positive return, including dividend payments. It’s up about 64%, helped by a rise in oil prices earlier this year.

Other popular sectors for dividends such as utilities, healthcare, and consumer staples have outperformed the market, albeit with negative absolute returns. The S&P 500 healthcare sector is down 3.6%, including dividends. Utility stocks are off 3%, and consumer staples are down 2%.

Katz, who runs a stock dividend strategy for clients, says he’s paring back some winning stocks in areas like healthcare and consumer staples. He has lightened positions in
AbbVie
(ABBV) and
Amgen
(AMGN), both up more than 20% this year. He also sold
Merck
(MRK), up about 45%, and trimmed Coca-Cola.

“There’s a pretty good likelihood that the things that did well this year are not going to be leaders in the next leg of the market,” he says, “and some of the things that did poorly are going to do better.”

An appealing sector for dividends now is financials, he says, including stocks such as
PNC Financial Services Group
(PNC), which yields 3.7%, and
Bank of New York Mellon
(BK), which yields 3.3%. “Everyone is looking at financials as if they have 2007-08 type of issues when we go into a recession, but they’re going in with great balance sheets, and credit quality is really good,” he says.

Like many strategists, Senyek cautions against chasing the highest-yielding stocks, due to the risk of dividend cuts if business fundamentals deteriorate. He prefers stocks in the second-highest quintile ranked by yield. Those stocks perform “better than the top-quintile-yielding stocks throughout the cycle,” he says, referring to a downturn in the economy.

One other strategy he favors is companies with high dividend growth combined with high free-cash-flow yields. Companies that screen well on those metrics include Bristol Myers Squibb (BMY),
Cigna
(CI), and
McKesson
(MCK). Each is up more than 30% this year, though the last two sport low yields. If the market keeps favoring dividend quality in 2023, they could all stay in the winner’s circle.

Write to Lawrence C. Strauss at lawrence.strauss@barrons.com

Credit: marketwatch.com

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