High Dividend ETFs may Offer a Pleasant Surprise

Markets ETF Trends

High-yield dividend stocks and exchange traded funds have been rewarding yield-starved investors for much of this year, but that trade has recently been threatened on concerns that defensive sectors, such consumer staples, telecom and utilities, are overvalued and that the Federal Reserve could be nearing its first interest rate hike of 2016.

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A desire for defense and yield benefited ETFs like the Shares Select Dividend ETF (NYSEArca: DVY), which was one of the better-performing dividend exchange traded funds through the first half of this year.

The current environment has been especially favorable for DVY because the ETF allocates nearly 32% of its weight to utilities stocks, this year’s best-performing sector. That gives DVY one of the highest weights to utilities names of any ETF that is not a dedicated utilities fund. On a trailing 12-month basis, DVY yields north of 3.1%.

Related: Low U.S. Interest Rates Boost International Dividend ETFs

Although Fed funds futures indicate dwindling chances of the U.S. central bank raising interest rates when it meets later this month and perhaps just one rate hike before the end of this year, at the most, investors have recently been departing rate-sensitive consumer staples and utilities ETFs in a big way.

For income investors, the good news is that some market observers believe high-yield dividend stocks may be able to weather Fed storms better than many investors are trained to believe. Additional good news comes in the form of the fact that defensive sectors may not be as pricey as previously thought.

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“Given the strong recent performance of high yielders, investors have raised concerns about excessive valuations. The data should allay these fears. More specifically, Utilities, Telcos, and REITs carry multiples of 17.3x, 13.8x, and 18.8x, respectively. The S&P 500’s P/E of 16.6x is exactly in line with the average of these three sectors. Each of these sectors trades at or below its 5-year average premium/discount to the S&P 500. This is the result of relatively mixed returns for high dividend stocks in preceding years,” according to an RBC note posted by Amey Stone of Barron’s.

Related: Best of Both Worlds With This Dividend ETF

Stocks with steady dividend yields reassure investors of a company’s strong financial health. Additionally, dividend-paying stocks typically outperform those that do not pay over the long haul, with less volatility, due to the compounding effect of dividends on the investment’s overall return.

For more news and strategy on the Dividend ETF market, visit our Dividends category.

iShares Select Dividend ETF

Tom Lydon’s clients own shares of DVY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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