Wall Street week ahead: high dividend stocks may find favour as market headwinds abound

High dividend yield stocks such as telecoms and utilities are looking more tempting as investors become increasingly nervous about the outlook for equities and as US Treasury yields hover near a 10-month low. The wide spread between the 10-year Treasury note and high-dividend payers, coupled with these stocks' reputation as a safer play, could tempt investors to move away from high growth names.
A nuclear test from North Korea on Sunday rattled investors when markets opened on Tuesday after the extended holiday weekend, pushing the yield on benchmark 10-year Treasury notes to a 10-month low. "If rates can stay down here you will see people begin to return to those days of owning high dividend stocks," said Rick Meckler, president of investment firm LibertyView Capital Management in Jersey City, New Jersey.
Investors typically prize high dividend players in a low rate, low growth environment, as they search for high yielding and stable instruments. Fund managers already seem to be picking up some of these stocks. On a sector basis, weekly inflows for utilities were among the strongest, relative to assets under management, at 1.9 percent according to data from Credit Suisse through September 1.
Stocks in the telecom and utilities sector have some of the highest dividend yields in the S&P 500. Telecom CenturyLink has a dividend yield of 11.4 percent, top in the index. Utilities FirstEnergy and Southern Co both have dividend yields above 4.5 percent. Meckler said investors are now more confident these sectors can compete with the yield on the 10-year at such a low level.
Goldman Sachs CEO Lloyd Blankfein issued a note of caution about the disparity between bond yields and equities at a conference in Germany on Wednesday, saying "When yields on corporate bonds are lower than dividends on stocks, that unnerves me." Stubbornly low bond yields can be of concern to equity players because they are forced to take bigger risks as they search for higher returns. They also raise red flags about the health of the economy.
Yields fell even further on Friday, to 2.016 percent, after New York Fed President William Dudley struck a less hawkish tone about rate hikes, while still defending them, in a Thursday night speech. The dividend yield on the telecom sector is 5.2 percent while the utilities sector holds a 3.4 percent yield compared with a 2.4 percent yield for the broad S&P 500 index.
Those sectors have had divergent fortunes this year, however, with utilities up more than 12 percent while telecoms have dropped more than 14 percent, the worst among the major S&P sectors. Telecoms also show a forward price to earnings ratio (PE) of 12.9, well below the 17.6 of the S&P 500. Utilities, however, are slightly more expensive with an 18.4 ratio, which could make them less attractive to investors even with the dividend premium.
In a recent note to clients, analyst Craig Moffett at MoffettNathansan said valuations for Verizon and AT&T were "enticingly low" with dividend yields "particularly attractive relative to the 10-year Treasury." The utilities sector has a strong 50-day negative correlation to the 10-year yield of 0.87, indicating the opposite directions they have travelled in. Telecoms, while still a negative 0.24, have a looser bond.
As investors weigh increasing risks for equities, including stretched valuations in what is typically a difficult period for stocks, the high dividend payers may be a safer play in a market that could be primed for a pullback. Tension with North Korea, economic disruption from major hurricanes and political wrangling in Washington are also among the issues investors have to contend with. "September and October are historically trying months for equities and add on to that geopolitical risk, it is somewhat prudent to be taking a little bit off the table here," said Anthony Conroy, president at Abel Noser in New York.