Hawkish FOMC means more tailwind for dividend stocks

By Peter Garnry, Head of Equity Strategy at Saxo Bank

The FOMC will push interest rates much higher from here to rein in inflation and with that lowering equity valuations. This means that higher P/E ratios, also called growth stocks, will suffer relative more compared to lower P/E companies and especially those with high dividend yields and that have proven their robustness over the past 10 years. Dividend stocks are in high demand and have been outperforming the global equity market by 14% since November and will likely continue to do well over the coming six months.

The monetary pivot in November 2021 kickstarted dividend investing

Since November last year when the Fed pivoted on its temporary inflation thesis and indicated that it would significantly tighten financial conditions to rein in inflation, dividend aristocrats¹ have outperformed the global equity market by 14.2% and are only down 10.7% this year compared to 21.2% for the MSCI World. The question is whether the relative outperformance can continue for dividend stocks.

The FOMC’s decision on Wednesday to hike the US policy rate by another 75 basis points and sending a hawkish signal through its dot-plot and economic forecasts will add more tailwind for dividend stocks. The reason for that is that higher interest rates will reduce equity valuations through a higher discount rate on future cash flows. Lower equity valuations will, all things being equal, have a larger impact on higher P/E ratio companies than those with low P/E ratios, because high P/E companies have a larger part of their value coming from cash flows expected far into the future.

The dividend aristocrats generally have lower valuation multiples and thus have less interest rate sensitivity. In addition, higher interest rates coupled with potential recession and uncertainty lift the value of companies with higher more predictable income stream in the short-term. It is worth noting that over the past five years, global dividend stocks have delivered a significantly worse return for shareholders than the global equity market.

There are many ways to define good dividend paying companies and in this equity note we have focused on the SPDR S&P 500 Global Dividend Aristocrats UCITS ETF, but there is also the iShares MSCI World Quality Dividend ESG UCITS ETF which focuses on companies with high dividend yield and quality characteristics (strong return on capital and strong balance sheets). Below we have listed the 10 largest holdings in each ETF.

SPDR S&P 500 Global Dividend Aristocrats UCITS ETF – 10 largest holdings

MSCI World Quality Dividend ESG UCITS ETF – 10 largest holdings

¹ S&P Global defines dividend aristocrats as the highest dividend yielding companies within the S&P Global Broad Market Index (BMI) that have followed a policy of increasing or stable dividends for at least 10 consecutive years.

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