Dividend ETFs Under Pressure as Interest Rates Rise

ETF Trends

Investors turned to non-cyclical, defensive sector exchange traded funds with high dividend yields during uncertain market conditions, but these sectors are starting to fall behind as riskier picks outperform in the bull rally and interest rates inch higher.

Telecom, utilities and consumer staples, the three sectors with the highest dividend yields, have been underperforming since the week ended May 3 when yields on the 10-year Treasury note started its 100 basis-point advance, Sam Stovall, Chief Equity Strategist  for S&P Capital IQ, said in a research note.

Within the S&P 500 sectors, telecom services has a 4.8% dividend yield and declined 8.6%; utilities has a 4.1% dividend yield and dropped 8.2%; and consumer staples has a 2.8% dividend yield and fell 2.8%.

The Vanguard Telecommunication Services ETF (VOX) is down 4.6% over the past month. VOX has a 3.0% 12-month yield.

The Consumer Staples Select Sector SPDR Fund (XLP) is down 3.4% over the past month. XLP has a 2.66% 12-month yield. [Keeping up With the Consumer…With ETFs]

The SPDR Utilities Select Sector Fund (XLU) is down 4.5% over the past month. XLU has a 3.77% 12-month yield.

The underperformance of defensive sectors also weighed on overall returns in broad dividend ETFs, especially in funds with a high allocation to utilities. [Biggest Low-Volatility ETF Trailing S&P 500 as Utilities Weigh]

Stovall lists out five reasons why higher rates pressure stock price performances: Slower economic growth due to rising credit costs. Higher interest expense as long-term debt is rolled over. Lower intrinsic value of share prices from discounted cash-flow models. More attractive bonds at higher rates. Onerous stock dividends due to higher payout ratios during declining EPS phase in a slowing economy.

“Price pressure was also related to each sector’s debt burden, as seen in their debt-to-capital (DTC) ratios, which hint at the sectors most likely to experience pressure in coming months from rising interest expense when they roll over this debt,” Stovall said.

Since May, Telecom DTC was 57.2%, utilities DTC was 50.5% and consumer staples DTC was 49.7%, whereas the average DTC for S&P 500 index was an average 38%.

“Since early May, not only did sectors with the highest yields fall the most in price, but they were also saddled with the highest average DTC ratios.” Stovall added.

For more information on dividend stocks, visit our dividend ETFs category.

Max Chen contributed to this article.

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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