Interest Rates: Good or Bad for Dividend Stocks?
By now, you’ve probably heard that interest rates will rise sometime
this year, with the only unknown being “which month?” Usually, such news
is accompanied by advice from market pundits saying that high-dividend
stocks such as utilities would lose value when interest rates rise.
Consequently, dividend paying stocks get hit every
time someone on TV opines that rate hikes are coming.
So what has happened to dividend stocks in past years
when interest rates rose?
January 1999 to January 2015
To find out, I picked six representative
high-dividend stocks and tracked their share price and dividend levels
over the 16 years ranging from January 1, 1999 to January 1, 2015.
I picked that timeframe because it covers two major interest rate
spikes. Using the 12-Month LIBOR (London Interbank Offered Rate) as a
gauge, rates spiked from a low of about 4% to a high of 7.5% in 2000,
and from around 1.4% to 5.7% in 2006.
My findings were surprising, at least to those espousing the
For example, I analyzed two Real Estate Investment Trusts (REITs)
that own commercial properties; office building owner Vornado Realty
(VNO) and shopping center owner Simon Property Group (SPG). Because
REITs don’t pay federal income taxes if they pay out at least 90% of
income to shareholders, they are typically high-dividend payers.
In both instances, the facts didn't support
conventional wisdom. Both Vornado and Simon enjoyed higher earnings and
increased their dividends after interest rates rose in 2000 and again in
2006. Here are links to charts showing
Simon Property share prices and dividends vs. LIBOR rates over the
Why Prevailing Wisdom is Wrong
Interest rates rise when the economy is strengthening, and when
the economy picks up; property owners can raise rents, driving earnings,
and hence, share prices higher. Further, according to the rules
governing REITs, higher earnings must translate to higher dividends.
Conversely, when the Fed forces interest rates down to battle a
weakening economy; falling rents and higher vacancies cut property REIT
earnings, triggering dividend cuts and share price drops.
However, recent history presents an exception. Since 2009,
interest rates have generally dropped while the economy has
strengthened. Over that timeframe, reflecting improving business
conditions, both Vornado’s and Simon’s share prices and dividends rose.
Thus, for property REITs, share prices and dividends were mainly driven
by business conditions, not interest rates.
What about utilities?
I checked two of the largest, Dominion Resources (D)
and Southern Company (SO). Both offer electric and natural gas
utility services in numerous states. Similar to the property REITs, both
Dominion and Southern shareholders enjoyed rising share prices and
dividend hikes when interest rates rose. Why? Utilities prosper in a
strengthening economy because their customers are using more natural gas
and electricity. Here are the charts for
The third category of stocks that I checked were
mortgage REITs. Unlike property owners Vornado Realty and Simon
Property, mortgage REITs invest in mortgages and other loans that are
secured by real estate. They profit by investing
money borrowed at
relatively low short-term rates in mortgages that pay higher long term
rates. Analyzing mortgage REITs Annaly Capital Management (NLY) and MFA
Financial (MFA), I found that unlike property REITs, when interest rates
rose, mortgage REIT earnings and dividends consistently dropped, and
One reason might be that rising interest rates reduce the value of a
mortgage REIT’s mortgage portfolio, forcing the REITs to write-down the
value of their assets, cutting earnings, and hence, dividends.
Here are the charts for
Dividend Stocks in General
To test dividend payers in general, you really need an
exchange-traded-fund that tracks an overall dividend payers index.
Dividend ETFs haven't been around enough to cover the entire 1999 to
2015 test period. However, the Dow Jones Select Dividend ETF (DVY)
started trading in December 2003, just in time to catch the 2006
interest rate spike. Here's a
link to a
DVY price chart showing that the stocks making up DVY's index moved up
in price in 2006.
Skimpy Study But Conclusions Probably Valid
Based on my admittedly skimpy study, only mortgage REIT investors
are likely to suffer when interest rates rise. Property REIT and utility
stocks should enjoy a good run.
Did I cherry pick these examples to prove my preconceived ideas? Nope.
My main problem was finding stocks trading since 1999 to use as
examples, especially for mortgage and property REITs, but not so much
for utilities. From my list of available
examples, I eliminated stocks influenced by company specific events such
as mergers and acquisitions, and then I picked the biggest players from
the remaining candidates. Since stocks in the same business sectors tend
to trade together, I’m confident that checking additional examples would
not change the conclusions.