Keeping tabs on the Federal Reserve seems to be a game of will-they-won’t-they. The Fed raised interest rates in December for the first time in nearly a decade. Now the key question is when the next rate hike will come.
Over the course of this year, Fed watchers have widely believed the central bank would raise interest rates at least once more.
Economists on average believed another interest rate increase would come by the end of the year, perhaps as early as the Fed’s June meeting. But in light of Friday’s weak jobs report, which revealed just 38,000 new jobs added in May, the Fed could decide to postpone the next interest rate hike.
For investors who are feeling confident the Fed holds interest rates steady and does not raise them at its June meeting, here are three of the best ways to invest.
Invest in Utilities
Utilities are arguably the most rate-sensitive sector. The reason is because utility stocks trade similarly to bonds. Utility stocks trade with much lower volatility than the market, and shareholders buy them for income, just as investors purchase bonds for interest income.
Utilities have large amounts of fixed, long-term assets. While an increase in short-term rates won’t immediately affect their capital structures, in time rising short-term rates typically leads to higher long-term rates. When utilities need to take out new long-term debt, it will likely be done at higher rates.
High-yield utilities like Southern Co. (NYSE: SO) stand to benefit the most from the Fed standing still on interest rates. Southern raised its shareholder dividend this year, for the 15th annual raise in a row. Furthermore, Southern has maintained a streak of 274 consecutive quarters in which its dividend rate is equal to or higher than the previous quarter.
Southern’s current dividend yield is 4.5%.
Invest in REITs
Real estate investment trusts, often referred to as REITs, are highly sensitive to changes in interest rates. The business model for REITs is to raise capital, often through debt, which they use to purchase real estate properties. These properties generate cash flow for the REITs, which fuels their impressive dividend yields.
If rates stay where they are now, it will allow REITs to continue raising cheap capital. This will maintain a wide spread between the rates they pay on their debt and the returns generated by their real estate investments.
One of the most popular REITs is Realty Income (NYSE: O), which bills itself as “The Monthly Dividend Company.” Realty Income pays its dividend each month, and has a long track record of raising its dividend.
In fact, Realty Income has a proven track record of providing excellent returns: Realty Income has returned 17% compounded annually since 1994. It has paid 550 consecutive monthly dividends, and has raised its dividend 85 times.
Realty Income’s tenants are mostly comprised of retailers, across a wide range of industries. Most of its tenants are drugstores, retailers and fitness centers. Realty Income offers a hefty 3.8% dividend yield.
Invest in Telecom
Lastly, the telecommunications sector is another rate-sensitive area. In recent years, telecoms have taken out a lot of debt to finance large acquisitions to fuel future growth. One such acquisition was AT&T (NYSE: T) purchasing satellite-TV provider DirecTV in a $49 billion deal.
The good news is that the merger has opened up significant growth opportunities for the company—AT&T now has more than 26 million customers in the U.S. and another 19 million in Latin America. The company grew revenue and free cash flow by 10% and 60% last year, respectively.
But the acquisition saddled AT&T with a lot of debt: it now has $122 billion of long-term debt on its balance sheet. AT&T already has a stretched balance sheet. If rates rise, it will have to pay more on debt financing going forward, which will put even more pressure on the company’s financial position.
If rates stay low, AT&T will have an easier time generating the earnings necessary to continue growing its divided.
AT&T has a 4.9% dividend yield and has raised its dividend for 32 consecutive years, which makes it a member of the S&P Dividend Aristocrats list.
The key takeaway is that if the Fed holds interest rates unchanged in light of May’s disappointing jobs report, it will be a boost to high-yield dividend stocks in the utilities, REITs and telecom sectors.
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