Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Stocks Are Priced for a Hawkish Fed Chair
Transcript
- Lucas: It's been a rough week for dividend investors, and the culprit is pretty clear — the bond market repricing for a more hawkish Kevin Warsh than anyone expected. Luna: Yeah, the ten-year shot back up to 4.49 percent yesterday, and some of the classic income names have taken real hits. Lucas: Right. Let's look at the numbers. Over the last five trading days through today, June 19th, Coca-Cola is down 3.3 percent. Johnson & Johnson dropped 5.2 percent. And Verizon, which we talked about a few episodes back when its yield first topped 5 percent, is off 5.7 percent. Luna: So VZ now yields close to 6 percent if you annualize the dividend at that lower price. That's a big number. Lucas: It is. And the question is whether that yield is compensation for real risk — like a potential dividend cut — or whether the market is just overshooting on rate fears. I think it's a bit of both. Luna: Let's talk about the Fed piece first. Chairman Warsh hasn't even taken the helm officially yet, but his recent comments have spooked the market. Lucas: Exactly. The headline from CNBC on Wednesday was that Gundlach said Warsh is 'not going to be the easy money chairman many hoped for.' And the market is pricing in maybe one more rate hike this year, maybe holding higher for longer. That changes the math for every dividend stock. Luna: Because if you can get 4.5 percent risk-free on a ten-year Treasury, suddenly a 5 percent dividend yield with equity risk doesn't look as compelling. Lucas: Right. And that spread compression is what's hitting these stocks. The Vanguard High Dividend Yield ETF, VYM, is down 0.7 percent over the week. Not terrible. But the Schwab U.S. Dividend Equity ETF, SCHD, is down 2.9 percent. That's a bigger move. Luna: SCHD has more exposure to some of the consumer staples and health care names that are getting hammered. It also has a slightly higher yield than VYM, so maybe it's more rate-sensitive. Lucas: I think that's part of it. But I want to zoom in on Verizon specifically. At $45.37, the stock is yielding about 5.8 percent. That's historically high for VZ. But the company carries a ton of debt — over $150 billion. In a higher-rate environment, interest costs eat into free cash flow, which is what pays the dividend. Luna: So you're worried about a cut? Their payout ratio on free cash flow has been creeping up, I think it's over 60 percent now. Lucas: It's around 65 percent depending on the quarter. And while that's not immediately dangerous, it doesn't leave much margin if earnings dip. The bond market is essentially saying, 'I need more yield to hold Verizon debt,' and the equity market is following suit. Luna: But isn't there a contrarian case? If the market is overreacting, you're locking in a nearly 6 percent yield from a company that has paid a growing dividend for over a decade. Lucas: There is a contrarian case. But you have to be comfortable with the idea that the dividend might not grow for a while, and that the stock could stay flat or decline further if rates keep rising. It's a total return question. Luna: What about Johnson & Johnson? Down 5 percent in a week. That's a name people count on for stability. Lucas: JNJ is a Dividend Aristocrat with 60-plus years of increases. But the stock is yieldier now — about 3.3 percent. The sell-off seems tied to both the rate move and some legal overhang from talc litigation. But the dividend is safer than Verizon's, in my view. Luna: Because the payout ratio is lower, around 45 percent of earnings, and the balance sheet is stronger. Lucas: Exactly. JNJ has an AAA credit rating. VZ is A-minus. So the market is pricing different levels of risk. The ten-year at 4.49 percent is a direct competitor for all of them, but the weaker credits feel it more. Luna: So what's the play for a dividend investor right now? Sit in cash? Buy the dip? Lucas: I think the most interesting move is in the mid-cap dividend space. We've talked before about how ETFs are shifting to mid-caps. The iShares Select Dividend ETF, DVY, has a ton of mid-cap exposure and it's actually flat this week. Up a bit, depending on the day. Luna: Because mid-caps tend to have less debt and more pricing power in niche markets? Lucas: Partly. They also haven't been bid up as much as large-cap dividend stocks in the low-rate years, so they have less valuation air to let out. And their dividends are often growing faster because the companies are in an expansion phase. Luna: So you're saying that in a rising rate environment, the rotation out of large-cap dividend stocks into mid-caps might have legs. Lucas: I think it does. Look at the Russell 2000 — small caps are down 0.9 percent this week, but mid-cap indexes have held up better. The dividend yield on DVY is around 3.4 percent, which isn't huge, but the payout ratios are more sustainable. Luna: It's also worth noting that the spread between the two-year and ten-year Treasury is still positive but narrowing — 27 basis points. An inverted curve would be worse for banks and financials, but we're not there yet. Lucas: Right. And that's a key point. The curve is flattening but still upward-sloping. That's actually a decent environment for dividend stocks that can grow their payouts. The danger is if we get a full inversion, which typically signals recession and then dividend cuts follow. Luna: So the bond market is not screaming recession yet, but it is screaming 'higher for longer' on rates. Lucas: Exactly. And that means dividend investors need to be more selective. Avoid the highest-yielding names with shaky balance sheets. Focus on companies with strong free cash flow, low payout ratios, and the ability to raise prices if inflation stays sticky. Luna: Like consumer staples that have pricing power — Procter & Gamble, Coca-Cola. Although KO is down this week, it's still a reliable dividend grower. Lucas: PG is actually flat this week, which is interesting. The market seems to view it as a safe haven. Its yield is only 2.4 percent, but the dividend growth rate is consistent. So maybe the market is saying, 'we'll pay up for quality.' Luna: That's the tension. Do you want yield now or yield growth over time? Lucas: And that's really the core debate for this episode. With the ten-year at 4.49 percent, you can get a decent nominal return without any equity risk. But you lock in that nominal return. Dividend stocks offer the potential for real income growth if the companies can raise payouts faster than inflation. Luna: And that's where I think the case for dividend investing still holds — you just have to be patient and pick your spots. Lucas: For sure. And speaking of patience, we should mention that the reason we can have these conversations without ads is because of listeners who support the show directly. Luna: Yeah, it's a small group, but it makes a real difference. If you've gotten value from our dividend deep dives, a couple of dollars a month at buy me a coffee dot com slash fexingo genuinely keeps these going. Lucas: And it lets us stay independent, which matters when we're talking about things like whether Verizon's dividend is safe. We're not sponsored by anyone telling us to spin it. Luna: Exactly. So back to that selectivity question — if you're building a portfolio today, what's your first move? Lucas: I'd start with the mid-cap dividend ETFs. They offer better growth potential and more reasonable valuations. Then I'd layer in some high-quality large-cap names that have sold off, like Johnson & Johnson, but only if you have a long time horizon. Luna: And avoid the temptation to reach for yield in names like Verizon unless you really believe the dividend is safe and you're okay with price volatility. Lucas: Right. The market is repricing risk under a new Fed regime. Dividend investors who adapt will be fine. Those who just chase yield might get burned. Luna: Good note to end on. Thanks, Lucas. Lucas: Thanks, Luna. We'll keep watching the data.