Dividend Stocks Are Setting Up Nicely For A Comeback

David Dierking

If you've been invested in dividend stocks over the past few years, it's been a rough ride. Not only have they mostly underperformed the broader market, they're probably not boosting your portfolio yield too much.

That might be starting to change though. Last week's market action indicated a few things to me.

  • Utilities outperformed the S&P 500 by a wide margin. This sector has been a continuous underperformer since the market hit its March bottom, but a return to this defensive sector could indicate a pivot to more conservative investments.
  • Treasuries continue to deliver gains despite the strong rebound in equities. Needless to say, this is unusual and highlights the current disconnect between the stock market and the bond market. I believe that the bond market is right more often than the stock market and, in this case, indicates that there's still a lot of cautious sentiment here.
  • Gold continues its strong year and has pushed above the $1800 level. If investors are worried about a correction in stocks, a declining dollar or the potential for higher inflation, commodities tend to outperform. Another indicator of investor worry.

If investors are truly ready to rotate into conservative equities again, dividend stocks (and ETFs) could be poised to lead. But it's probably worth targeting specific areas of the dividend stock universe.

I typically use three different ETFs to represent the three primary pillars of dividend stocks.

  • Dividend Growth - ProShares S&P 500 Dividend Aristocrats ETF (NOBL)
  • Dividend Quality - FlexShares Quality Dividend Index ETF (QDF)
  • High Yield - SPDR Portfolio S&P 500 High Dividend ETF (SPYD)

As you can see, it's really only been the dividend grower segment that's been able to hang with the market.

^SPX_NOBL_QDF_SPYD_chart-3

With the coronavirus wreaking havoc on the economy, those brave enough to stick with dividend equities have migrated towards the sturdiest of long-term dividend payers (and even that hasn't been able to avoid all dividend cuts).

NOBL has done relatively well as a flight-to-safety play. SPYD investors have found out that high yield often comes with high risk. Since this is where many of the dividend cutters and suspenders are coming from, investors have raced for the exits and this group has underperformed badly. The quality component of QDF has been in favor lately, but the fund's strategy also targets higher yields, so that ETF has been getting dragged down as well.

Lately, those who have gone yield chasing have been punished, while those sticking with safer dividend growers haven't been rewarded with yield.

^SPX_NOBL_QDF_SPYD_chart

The 6% yield of SPYD sure looks attractive on the surface, but at least part of that yield figure is artificially inflated. As the fund's total returns have shown, many of those stocks have sold off significantly, some due to dividend cuts, and those high yields are a function of low share price.

NOBL has hung tough, but the dividend aristocrats aren't known for their yields. Even the modest 2.2% rate is higher than it's been over much of the past few years.

But the markets could finally be signaling a changing of the guard.

It was a modest performance boost last week, but dividend stocks significantly outperformed the S&P 500.

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At a quick glance, this chart doesn't look so impressive. We've seen these kinds of fits and starts with dividend stocks several times in 2020, but here's why this time could actually be indicating a broader sentiment change.

  1. Utilities and healthcare led the way. Utilities have been a steady underperformer since March, but last week's move could be the start of a bigger defensive pivot. The Treasury market has consistently held firm despite the rally in stocks recently. If Treasuries and utilities begin both showing outperformance again, it could confirm that conservative stocks, including dividend payers, are coming back into favor.
  2. Gold continues to rally. Gold is really more of an uncorrelated asset as opposed to a defensive asset, but the fact that it's rallying suggests some investor worry. Whether it's economic concerns or inflation worries, the strong move in precious metals is indicating a potential risk-off move.

It's still early to be calling this a confirmed rebound in dividend stocks, but the market signals are starting to point in that direction. A COVID-fueled economic slowdown, cratering GDP and corporate earnings, the threat of higher inflation and underlying strength in Treasuries all support the notion that more defensive issues are gaining traction.

Dividend stocks could certainly be among that group.

More ETF Research

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The 10 Best Dividend ETFs You Can Add To Your Portfolio

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The New TVIX? Another 2x Leveraged VIX ETF Could Be Coming

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