Interest rates are in a state of global dislocation and discord. Some $15 trillion of worldwide debt is negative yielding -- that's 43% of all bonds outside the U.S.. And there are now growing whispers of this madness coming to the U.S.
In fact, you could argue that negative yields are already here: the inflation rate was 1.8% for the 12 months ending July 2019, and as of August 30, the U.S. Treasury 1-year, 2-year, 3-year, 5-year, 7-year, 10-year, and 20-year bonds all had rates that are less than 1.8%. That is a negative real yield, meaning you lose purchasing power by holding these assets.
Jerome Powell is a begrudging participant in this new dovish path the Federal Reserve has reembarked on. Since last year, we've abruptly gone from two projected rate increases in 2019 to two to three cuts predicted as of this writing. Yet unemployment remains at historic lows, GDP growth was 3.1% in Q1 and 2% in Q2 and corporate earnings were much better than expected with 5.1% growth, versus expectations that they would contract.
None of this positive U.S. data seems to matter, though. We are entering uncharted territory and the Fed seems to be along for the race-to-the-bottom ride. So what performs well when rates are so low?
Stocks should be poised to continue their bull trend. "Risk-free" interest rates (e.g. U.S. debt) are the bedrock of the discounted cash flow models that underlie equity valuations and the net-present-value calculations that determine whether or not a company makes a capital investment. The lower rates are, the less those cash flows are discounted and the higher the present valuation is for them and investments of any kind. This means stock prices are calculated as higher, and capital investments have lower thresholds of profitability in order to be accepted.
Within the equity universe, there is a particular cohort that behaves notably well: high-dividend stocks. Yield becomes even more of a scarcity when rates are pulled towards zero and as a result, investors become attracted to solid blue chip companies with long histories of attractive dividend payments.
What you see above is the S&P 500 from 2008 to 2019 and the Vanguard High Dividend Yield ETF (VYM) - Get Report , iShares Core High Dividend ETF (HDV) - Get Report , and SPDR S&P Dividend ETF (SDY) - Get Report . Since the nadir of 2009, SDY leads in outperformance with a return approximately 150% better than the market, and HDV and VYM both exceeding the S&P by roughly 80% in the same timeframe. That's a substantial alpha that is only moderately more volatile than the broader market. There is no reason why this trend should not remain intact while rates continue to see pressure.
If you're looking for specific companies, the below symbols show up multiple times in the top 10 holdings or are significant positions of SDY, VYM, and HDV, and should be solid high-yield selections in this environment. If you want to circumvent the small management fees that accompany owning these ETFs, a basket of these should perform nearly the same.
Exxon Mobil (XOM) - Get Report , Pfizer (PFE) - Get Report , AT&T (T) - Get Report , Verizon (VZ) - Get Report , Philip Morris (PM) - Get Report , AbbVie (ABBV) - Get Report , Johnson & Johnson (JNJ) - Get Report , Procter & Gamble (PG) - Get Report , Chevron (CVX) - Get Report , JPMorgan Chase (JPM) - Get Report , Coca-Cola (KO) - Get Report , Cisco Systems (CSCO) - Get Report , Merck (MRK) - Get Report .
The author is long AbbVie