Harry Domash's Winning Investing


Rising 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 conventional wisdom.

Property REITs
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 Vornado and Simon Property share prices and dividends vs. LIBOR rates over the tracked timeframe.

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.

Recent History
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 Dominion and Southern.

Mortgage REITs
he 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 vice versa.

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 Annaly and MFA.

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.

published 5/15/15

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