Rida Morwa | Jan 17, 2016 05:06PM ET
Amidst the low interest rate environment of recent years, popularity of dividend paying stocks has increased among investors and asset allocators in an effort to supplement returns for income-hungry investors, baby boomers, and retirees. Typical high-dividend sectors, which include real estate REITs, utilities, telecommunication and consumer staples have outperformed during the past few years. But will this outperformance continue? In this article, I will argue for the bullish case of these securities in 2016, as their sectors are the best to buy in for a stable and long-lasting income.
The Outlook of US Interest Rates
After seven years of the most accommodative monetary policy in U.S. history, the Federal Reserve raised interest rates by 25 basis points in December 2015. However, it is unlikely that it will raise interest rates again as global risk factors are still running high:
International Interest Rates
With Europe, Japan, and China all facing deflation and lower growth, they are all likely to increase their continued aggressive Quantitative Easing (QE), by further easing money supply and lowering interest rates. Such actions make equity investments even more attractive than they were in 2015.
US Government Bond Yield
Historically, many investors looking for income have sought the security of risk-free government bonds. But with yields on some government bonds, especially those of the US government currently below inflation and resulting in negative real yield. Furthermore the 10 year US Government Bond yield of 2.03% is below the average S&P yield of 2.27% and that of the Dow Jones Industrial Index of 2.78% (source: wsj.com).
Demand for High-Yield Products
Demographic trends will continue to favor dividend-paying stocks as retiring baby boomers and retirees drive demand for income strategies to support their lifestyles, and their longer life expectancy.
Typical Sectors in the High-Dividend Space
Typical high-dividend sectors, which include real estate REITs, utilities, telecommunication and Consumer staples have outperformed during the past few years. The following is the list of some of the highest yielding Exchange Traded notes (ETFs) in each of the above sectors:
I have added to the list of high yield ETFs above the Business Development Companies (BDCs) sector. These companies make loans to and invest in a wide range of privately-held small and middle- private companies in need of financing. They are effectively bond proxy stocks, and with an average yield above 9%, they do look attractive. BDCs usually perform well in a healthy US economy, as their loan default ratio goes down. The BDCs pass on almost all of their income to investors, as mandated by law, and often distribute at least 90% of their taxable income, so dividend is usually variable.
Conclusion
The current worldwide environment of low inflation and moderate growth is here to stay for the foreseeable future. History has shown that when inflation is low, there is a positive effect on equity prices, especially those offering high dividends. With the two main alternatives, cash and bonds, still having unattractive returns, income investors have no other place to go but to stick to high dividend equities, which will provide the safest and wisest investment strategy for 2016.
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