The traditional investment strategy of chasing robust returns in the stock market is no longer the only game in town. With government-bond yields reaching their highest levels in over a decade, investors face a new dilemma.
Coupled with a stagnant stock market, the number of stocks that offer comparatively high yields has declined steadily. As of Friday, there were only 34 stocks in the S&P 500 with a dividend yield above that on the six-month Treasury bill, according to Birinyi Associates.
That represents a stark shift from the past decade when interest rates were near zero and hundreds of stocks within the index offered higher yields.
Investors who view U.S. government bonds as safer than even blue-chip stocks say it is difficult to justify putting money into the relatively risky stock market. They argue that the added chance of a company enduring a business slump outweighs the extra yield from a dividend-paying stock, especially given the uncertain economic outlook.
“There’s no reason whatsoever to buy a risky company just because it’s in the same yield ZIP Code as cash,” says Macro4Micro editor Glenn Reynolds, who has over 80% of his portfolio in cash.
The state of the economy remains a significant factor for investors this year, with a focus on the path of interest rates. The yield curve remains sharply inverted, with short-term interest rates higher than longer-term rates, reflecting the uncertainty surrounding the economy’s long-run direction.
The cautionary message to equity investors from the yield curve is clear, says Ryan Hedrick, portfolio manager of the T.Rowe Price value fund.
Despite the market turmoil, companies in the S&P 500 continue to increase dividend payouts to investors, paying out a record $564.6 billion in 2022.
The list of highest-yielding stocks includes many old-economy businesses. These companies usually return cash through dividends or repurchase their stock when the business generates more cash flow than needed to fund operations.
Although dividend-paying stocks still play an essential role, even with interest income from bonds readily available, Mr. Hedrick favors stocks in more defensive sectors, such as healthcare, consumer staples, and property and casualty insurance.
However, dividend-paying stocks can still present risks if it becomes too expensive for companies to afford the payouts. Last month, Intel Corp. announced that it would cut its dividend by 66% to save money, as the semiconductor company faces a short-term demand crunch while pursuing expensive factory expansions.
While stocks have long been the go-to option for investors seeking robust returns, government bonds’ soaring yields are altering the investment landscape.
With dividend yields declining and the uncertain economic outlook, investors must choose between the relatively risky stock market and the safer haven of government bonds.
Despite the risks, dividend-paying stocks, particularly in defensive sectors, can still provide an important source of income for investors.