Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Stocks Are Hedging Against a Steepening Yield Curve
Transcript
- Lucas: So the yield curve has been doing something interesting lately, and it's creating a pretty specific opportunity for dividend investors. As of this week, the 10-year Treasury is yielding 4.55 percent, the 2-year is at 4.13, so the spread is about 40 basis points. That's actually down a couple of basis points from last week, but the bigger story is that the curve has been steepening over the past month. Luna: Right, and when the curve steepens, it usually means the market expects stronger growth or maybe higher inflation down the road. But how does that translate to dividend stocks specifically? Lucas: Great question. The key is to think about the 'duration' of a dividend stock — how sensitive its price is to changes in interest rates. A utility stock with steady, long-dated cash flows is like a 30-year bond. When long-term yields rise, its present value drops a lot. But a stock like Altria, MO, which has a high yield around 8 percent but less predictable long-term growth, behaves more like a shorter-duration asset. Its price is less sensitive to the 10-year yield moving. Luna: So you're saying in a steepening environment, you might want to lean into higher-yielding stocks that have shorter effective duration, and maybe avoid the classic long-duration dividend payers? Lucas: Exactly. And the data over the past five days supports that. Look at Realty Income — ticker O — up 4.5 percent. That's a triple-net lease REIT, long-term leases, but it's also benefiting from the market pricing in that rates aren't going to spike forever. And consumer staples like Coca-Cola, KO, up 3.9 percent, or Procter & Gamble, up 3.1 percent. These are relatively short-duration because their earnings are tied to everyday spending, not long-term contracts. Luna: Meanwhile, the S&P 500 is basically flat, up only 0.3 percent. So dividend stocks are actually outperforming the broad market this week. Lucas: They are. And I think part of that is a rotation out of the mega-cap growth names that have been driving the index, and into income. The NASDAQ is actually down 0.2 percent over the same period. So you've got money flowing into dividends as a hedge against uncertainty, but also because the yield on offer is compelling when the 10-year is at 4.55. Luna: Let's talk about Realty Income specifically. It's a REIT, so it has to pay out 90 percent of its income as dividends. But with long-term leases, isn't it more rate-sensitive? Lucas: It is, but the market seems to be looking past that. The stock yields about 5.4 percent right now, and the dividend has grown for over 100 consecutive quarters. So investors are buying it for the growth potential and the diversification. Plus, REITs have been beaten down over the past two years as rates rose. Now that the curve is steepening but rates aren't spiking higher, people are seeing value. Luna: What about Verizon? It's up almost 6 percent in five days, which is huge for a stock that usually moves a percent or two. Lucas: Yeah, VZ is a great example of a shorter-duration high-yielder. Its dividend yield is over 6 percent, and the business is more about subscriber cash flows than long-term contracts. Plus, the company has been deleveraging. In a steepening curve, if the short end stays anchored, companies like Verizon that have a lot of debt can actually benefit because they refinance at lower short-term rates while their revenue grows with inflation. Luna: So the playbook here is: focus on stocks with high current yield, stable or growing dividends, and less sensitivity to long-term rates. That's basically the opposite of what worked when the curve was inverting. Lucas: Right. When the curve was inverted, everyone wanted long-duration, because the yield on the long end was actually lower than the short end. Now that the curve is normalizing, you want to shorten up. And the sectors that fit that are consumer staples, some REITs like O, telecom like VZ and T, and tobacco like MO. Even healthcare — Johnson & Johnson is up 3.7 percent this week. Luna: And it's not just about the yield. It's about the total return potential. If you can get a 4-6 percent yield plus some capital appreciation as rates stabilize, that's a solid risk-adjusted return. Lucas: Exactly. And I think that's why we're seeing this rotation. The SpaceX IPO frenzy this week — $75 billion raised, valuation north of $2 trillion — that's pulling a lot of speculative money, but the more institutional money is saying 'I'll take the safe 5 percent and sleep well.' Luna: That's a huge contrast. Speaking of keeping things going, a quick note: if you find these conversations helpful, we keep the show ad-free and listener-supported. A couple of dollars a month genuinely makes a difference — buy me a coffee dot com slash fexingo. It helps us keep doing what we do. Lucas: Yeah, it really does. And we appreciate every bit of support. So back to dividends — one more thing to watch is the payout ratio. As rates rise, companies with high payout ratios are more at risk of cutting dividends if their borrowing costs increase. So in a steepening curve, you want to see a payout ratio under 60 percent for safety. Luna: Verizon's payout ratio is around 50 percent, so that's fine. Altria is higher, around 80 percent, but their cash flow is strong. What about Procter & Gamble? Lucas: PG is at about 60 percent, which is very manageable. And they have pricing power because they sell necessities. So even if input costs rise, they can pass it on. That's the kind of stock you want in a steepening environment where inflation might tick up. Luna: So to sum up: steepening yield curve means favor shorter-duration dividend stocks, high current yield, and sectors with pricing power. Avoid long-duration utilities and REITs with very long leases unless you're getting a big discount. Lucas: Perfect summary. And keep an eye on the 10-year yield. If it breaks above 4.6 or 4.7, you might see another leg of rotation. But for now, the setup looks favorable for income investors.