Dividend stocks have trounced the market

Dividend-paying stocks have become a surprising success as rising interest rates continue to batter equity markets.

According a recent Morningstar report, the Morningstar Dividend Yield Focus Index recovered roughly 2% for the year through late October while the Morningstar US Market index lost 19.2%, reported Institutional Investor.

Given the size of the discrepancy, the author concluded that dividend payers "had shown considerably more robust" than other forms of shares during the market instability in 2022.

The findings fly in the face of the conventional wisdom that dividend stocks underperform in a rising-rate environment.

Proponents of this theory contend that elevated interest rates reduce the attractiveness of stable income from equities and increase the appeal of new issues of fixed-income products. Additionally, some investors claim that rising rates make it more difficult for businesses to service debt, much less maintain strong dividend distributions.

“It’s especially surprising because we’ve seen six interest rate hikes in 2022…but there’s this staggering margin of outperformance [by dividend stocks],” said Dan Lefkovitz, strategist at Morningstar Indexes. 

When Lefkovitz realized that dividend stocks lost less than the broader equities market a few months ago, he started paying more attention to dividend stocks. From his research, he concluded there was no direct correlation between dividend stock performance and interest rate levels.

Part of the reason dividend stocks may succeed in a rising-rate environment, according to Ed Clissold, chief U.S. strategist at Ned Davis Research, is that these companies typically have low beta, which means they are less volatile than the general market.

“When interest rates rise quickly, it tends to be negative for the stock market,” he said. “When that happens, investors generally prefer low beta companies that are more defensive.” He added that defensive stocks are also often dividend payers.

According to Matt Quinlan, portfolio manager in Franklin Templeton's equities unit, dividend stocks' source of income will be alluring if market volatility persists.

Quinlan emphasized that dividend stocks have broadened their focus recently to include sectors including healthcare, banking, and telecommunications in addition to their traditional blue-chip businesses. Financial, industrial, and tech companies have also jumped on the dividend-paying bandwagon.

Even if the economy experiences a recession in 2023, Clissold believed that dividend stocks will remain a wise investment.

Because dividend reductions typically rise sharply during recessions, he stressed: “What becomes very critical at this point, though, is [finding companies whose] dividends are not going to be cut.”