Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Aristocrats Adapt to a Steepening Curve
Transcript
- Lucas: So the ten-year Treasury is sitting at 4.68 percent, and the two-year is at 4.23 — that gap has widened to 47 basis points, the steepest we've seen in months. Luna: And for dividend investors, that's not just a number. That's real competition. Lucas: Exactly. When the ten-year yields close to 4.7 percent, you're asking yourself why take equity risk for a 3 percent dividend. But the market is actually rewarding some payers more than others this week. Coca-Cola is up 4.2 percent over five days, while Johnson & Johnson is down 3.6 percent. Luna: That's a pretty stark divergence. Both are dividend aristocrats, both are defensive. So what's driving the split? Lucas: I think it comes down to how the market is pricing free cash flow coverage right now. Coca-Cola's earnings are steady, they've got pricing power, and their dividend is well covered. Johnson & Johnson, on the other hand, is dealing with talc litigation overhangs and a more uncertain cash flow picture. Luna: So it's not just about yield, it's about the quality of that yield. Lucas: Right. And in a steepening curve, that quality premium gets amplified. Investors are more discriminating because they have a real alternative in bonds. So a company like Coca-Cola, with its stable operating cash flow, gets bid up, while a company with legal overhangs gets sold off. Luna: Let's talk about that free cash flow metric. You mentioned it in episode 131, but how do you actually calculate it for a dividend stock? Lucas: It's pretty simple. You take operating cash flow, subtract capital expenditures, and that gives you free cash flow. Then you compare that to the total dividends paid. If that ratio is above one, you're covering the dividend from cash flow, not from debt or one-time items. Luna: And when the curve steepens, why does that matter more? Lucas: Because a steepening curve often signals that the market expects growth and inflation. That means companies might need to reinvest more capital. If they're already paying out most of their free cash flow, they have less flexibility. Conversely, companies with high coverage can maintain or grow dividends without straining. Luna: So Coca-Cola's coverage is probably pretty strong. Lucas: Historically it's been around one point two, one point three times. And that's why they can raise the dividend every year for over sixty years. Johnson & Johnson, on the other hand, has seen its coverage dip below one in recent quarters due to legal settlements. Luna: That explains the market reaction. But what about the other side of the curve? The two-year is at 4.23 percent, which is still fairly high. Lucas: That's the front end, and it's signaling that the Fed is on hold. We saw the effective fed funds rate sitting at 3.63 percent in late July, and the market is pricing no cuts anytime soon. So short-term cash instruments are yielding over 4 percent as well. Luna: So dividend investors are competing not just with long-term bonds, but also with money market funds and short-term Treasuries. Lucas: Absolutely. And that's why we're seeing some rotation within dividend strategies. The high-yield names like Altria are down 6.3 percent this week, while growth-oriented dividend payers like Coca-Cola are up. Luna: Altria's drop is pretty dramatic. What's driving that? Lucas: Part of it is regulatory concerns, but part of it is that when the ten-year yields 4.7 percent, a stock with a 7 percent dividend but declining volumes becomes less attractive. Investors are asking whether that income is sustainable. Luna: So the market is doing a quality rotation within dividends. That makes sense. Lucas: And it's not just individual stocks. Look at the ETFs. The Vanguard High Dividend Yield ETF is down half a percent this week, while Schwab's US Dividend Equity ETF is up slightly. That's a sign that the market is favoring quality over pure yield. Luna: Because Schwab's fund has a higher tilt toward companies with consistent dividend growth, right? Lucas: Exactly. It screens for ten consecutive years of dividend growth, not just the highest yield. And in a steepening curve, that screen matters more than ever. Luna: So if you're an investor, how should you adjust your approach? Lucas: You should focus on free cash flow coverage first. Look at the payout ratio relative to free cash flow, not just earnings. And don't chase the highest yield without checking the balance sheet. Luna: But isn't that always the advice? Lucas: It is, but the discipline pays off more in this environment. Because when bonds are yielding 4.7 percent, you can't afford to be sloppy. The market will punish any sign of weakness. Luna: I think that's a really good takeaway: quality dividend stocks with strong cash flow coverage are the ones that will outperform as the curve steepens. Lucas: And you don't need to abandon dividend investing altogether. You just need to be more selective. There are still plenty of companies that can grow their dividends at 6 to 8 percent annually, which is better than a 4.7 percent bond. Luna: Especially if you're reinvesting those dividends over time. Lucas: Right. And that's the long-term game. You're not buying a bond that pays a fixed coupon for ten years. You're buying a growing stream of income that compounds. Luna: That's a compelling argument. But what about the risk that rates keep rising? The 30-year is already at 5.21 percent. Lucas: That's the big question. If long-term rates keep climbing, dividend stocks will feel more pressure. But the market seems to think the steepening is nearing its peak. The 30-year only moved a basis point this week. Luna: So maybe the worst is over for bond yields. Lucas: Possibly. But even if yields stabilize, the level is high enough that investors will remain selective. That's why we're seeing this split between winners and losers in the dividend space. Luna: Speaking of selective, I noticed that the S&P 500 is up 1 percent this week, while the small-cap index is down. That's another sign of quality preference. Lucas: Yes, and that's consistent with the dividend rotation. Investors are sticking with larger, more stable companies that have pricing power and strong balance sheets. They're not reaching for risk. Luna: So the message is clear: in a steepening curve, dividend investing is still viable, but you have to be smart about it. Lucas: Exactly. And the companies that are thriving are the ones with durable cash flows and a track record of raising dividends. Coca-Cola is a great example. They've raised their dividend for 63 years straight. Luna: That's a powerful track record. And it's not just about the past, it's about the future. As long as they keep generating cash, they can keep growing that dividend. Lucas: Absolutely. And that's the kind of income stream that can really compound over time. A 3 percent yield with 6 percent annual growth doubles your income in about twelve years. Luna: That's a nice way to think about it. Lucas: And you know, this kind of analysis is why we love doing this show. It's not just about picking stocks, it's about understanding the underlying mechanics. Luna: Yeah, and it's also why we appreciate the listeners who support the show. You know, a small group of you chip in monthly through buy me a coffee dot com slash fexingo, and that's what keeps this going without ads. Lucas: It really does. Every contribution helps us research these topics and bring you the data you need. So thanks for that. Luna: And it lets us stay independent and focused on what matters to you. So if you've gotten value from these episodes, consider joining them. Lucas: Now, back to the steepening curve. One more thing to watch is the front end. The two-year yield has been creeping up, and that could signal that the market is pricing in a potential Fed hike later this year. Luna: That would be a shift from the current flat stance. Lucas: Right, but for now, the Fed seems comfortable holding at 3.63 percent. So dividend investors have a window to lock in quality names before any potential move. Luna: Good. So the takeaway is: focus on free cash flow coverage, favor dividend growers, and be mindful of the rate environment. Lucas: And that's the essence of smart dividend investing in 2026.