Why Investors Are Flocking Back to Dividend Stocks

Stocks have been on a furious run the last few weeks. And dividend stocks have led the charge. Here’s why that trend should continue.
A month ago, investors were abandoning stocks as if they were jumping out of a rowboat before a tidal wave hits. Now stocks are back at all-time highs.
The rush back to stocks was fast and furious. The rush back to dividend stocks was even faster.
The S&P 500 has risen 9.4% since hitting bottom on Oct. 16. Dividend stocks, as measured by the SPDR S&P Dividend ETF (SDY), have risen a full 10% during that time. Admittedly, that’s not a major difference. But it shows the appetite investors still have for dividend stocks even after the Fed’s latest comments about raising interest rates.
The Federal Open Market Committee recently hinted at finally raising short-term interest rates from near zero, perhaps as early as next summer. As I wrote last week, it’s dangerous to read too much into what the Fed says or means in its phrasing of certain words. Even if the Fed does raise the federal funds rate as early as next summer, that’s no reason to get rid of your dividend stocks just yet. It’s only November.
Fortunately, most investors don’t seem to be in much of a rush to dump their dividend stocks. Just the opposite, in fact. Some of the most prominent dividend payers have been on fire in recent weeks.
Take a look at how some of these large-cap dividend stocks have performed since the tide turned on Oct. 16:

  • Johnson & Johnson (NYSE: JNJ): +12.3%
  • Target (NYSE: TGT): +9.7%
  • Altria (NYSE: MO): +10.5%
  • Walgreen (NYSE: WAG): +12.6%
  • McCormick & Co. (NYSE: MKC): +9.8%
  • Lowe’s Companies (NYSE: LOW): +12.6%

And those gains don’t include the high yield that accompanies long-term dividend growers.
My point is this: We don’t really know when the Fed will raise interest rates. It could be six months from now. It could be a year from now. Regardless, when it happens, short-term interest rates won’t automatically jump back to the 5% level they sustained for most of 2006-2007. The federal funds rate hasn’t been higher than 0.2% since 2008. It will take time for rates to get back up to respectable levels.
For proof, look back to the last time interest rates were low. In late 2003 and early 2004, the federal funds rate hovered around 1%. In June 2004, it finally started to escalate. It took almost a full year for rates to top 3%, and 18 months for rates to top 4% (see chart below).

Effective Federal Funds Rate, Last 20 Years


This time, interest rates are starting much lower – at mere fractions of 1%. Fed officials project that rates will get to 1.4% by the end of 2015 and 2.5% by the end of 2016. Currently, the average yield among S&P 500 stocks is 1.9%. In other words, according to the Fed’s own projections, we’re about two years away from short-term interest rates yielding more than your average dividend stock.
Dividend stocks are still the best place to be if you’re an income investor. When those stocks are performing the way they have in the past month, that’s especially true.
Even with whispers of interest-rate hikes, dividend stocks haven’t lost their appeal on Wall Street. Given that everything the Fed does is at a snail’s pace, that isn’t likely to change anytime soon.

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