Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / Why Dividend Aristocrats Lag in a Steepening Curve
Transcript
- Lucas: So the S&P 500 is up two point three percent over the past five days, and the Nasdaq is up four point two — yet Johnson and Johnson is down four point six percent, Procter and Gamble down two point six, and Altria down almost nine percent. That's a brutal divergence for dividend investors. Luna: It feels like the market is rewarding growth and punishing safety. But is this just a short-term rotation, or is something structural going on with income stocks? Lucas: It's a bit of both, but the real driver is the yield curve. The ten-year Treasury is at four point seven five, up from four point six eight last week, and the two-year is at four point two eight. That widening spread is making long-duration assets less attractive, and for many dividend aristocrats, their bond-like characteristics are a liability right now. Luna: Before we dig deeper — for anyone who values these kinds of market breakdowns, we keep this show ad-free thanks to listener support. If you'd like to help, you can buy us a coffee at buy me a coffee dot com slash fexingo. Every bit helps us keep diving into these numbers. Lucas: Exactly — and speaking of numbers, let's look at what's happening with the curve. The thirty-year is at five point two seven, so the long end is really moving. That's tough for dividend stocks that compete with bonds for income-focused dollars. Luna: So when the thirty-year yields over five percent, why would anyone hold Procter and Gamble at under three percent yield? Lucas: That's the million-dollar question. And the answer is that not all dividend stocks are created equal. Some have enough pricing power and cash flow to keep growing their dividends even as rates rise. Others are more bond-like and get hammered. Luna: Let's talk about Coca-Cola, since you mentioned it. It's down one point six percent this week, actually holding up better than most. Lucas: Right, and that's not an accident. Coke has incredible free cash flow coverage — its dividend is covered something like two and a half times by free cash flow. That gives investors confidence that even if the economy slows, the dividend is safe and can keep growing. Luna: So it's not just about yield, it's about the security of that yield. What about Johnson and Johnson — it fell four and a half percent. Is that purely the curve, or is there something company-specific? Lucas: Johnson and Johnson is a great example of a company with a strong balance sheet but slower growth. It's more sensitive to the long end of the curve, and when the ten-year jumps, the present value of its future dividend stream drops. Plus, there's been some rotation out of healthcare into tech this week. Luna: So is the lesson that dividend aristocrats are becoming less relevant in a steepening environment? Lucas: Not at all. The lesson is that you need to be more selective. The aristocrat label doesn't guarantee performance. You have to look at free cash flow coverage, pricing power, and how much of the business is tied to long-term contracts that might lag inflation. Luna: That makes sense. But how does the steepening curve actually affect these companies' fundamentals, not just their stock prices? Lucas: For a company like Procter and Gamble, higher long-term rates raise the cost of carrying debt, even though they have investment-grade ratings. More importantly, it increases competition from bonds for investor dollars — that's a demand-side effect on the stock. But their underlying earnings are still growing, so it's more of a valuation issue than a business issue. Luna: So the market is repricing these stocks to reflect the opportunity cost of holding them versus Treasuries. That's a big shift from a few years ago when rates were near zero. Lucas: Exactly. And look at Altria — down eight point eight percent this week. That's not just the curve. There's likely some regulatory news or sector-specific pressure, but it also has a higher beta to interest rates because of its debt load and the fact that its cash flows are mature and declining slowly. Luna: So when you're picking dividend stocks now, what are the key criteria? Free cash flow coverage is one, you mentioned that. What else? Lucas: I'd look at pricing power — can they raise prices with inflation? Companies like Coca-Cola and Procter and Gamble have that. Also, look at the duration of their cash flows. Utilities and real estate investment trusts are more bond-like because their revenues are often tied to long-term contracts or leases. Those are going to feel more pain in a steepener. Luna: Speaking of real estate investment trusts, Realty Income is down three percent this week. That seems consistent with what you're saying. Lucas: Exactly. And I think the big takeaway is that a dividend stock's yield relative to the ten-year Treasury matters a lot. If the spread is too thin, investors will move to bonds. But if a company can grow its dividend at a high rate, that compensates for a lower starting yield. Luna: That's a good point. So what should income investors do right now — rotate out of dividend aristocrats entirely, or just be more selective? Lucas: Definitely be selective, not exit. I'd look for companies with a track record of dividend growth even in tough times — like Johnson and Johnson, which has raised its dividend for sixty years. But I'd also be patient and wait for better entry points, because the market is still repricing. Luna: So you're saying Johnson and Johnson might be a buy if it drops further? Lucas: Potentially. If the yield gets to around three and a half percent, and their free cash flow coverage is solid, that could be a compelling entry. But you need to do your own analysis on the growth trajectory. Luna: One more thing — how does the oil price spike from the Iran conflict factor into this? We saw diesel prices jump in California. Lucas: That's interesting because energy costs can affect consumer staples companies like Coca-Cola and Procter and Gamble, though they have pricing power to pass on some of those costs. But higher oil also boosts inflation expectations, which could push the Fed to stay higher for longer — that's bad for long-duration dividend stocks. Luna: So it's a double-edged sword: higher input costs and higher rates. That explains why even defensive names are getting hit. Lucas: Exactly. And that's why you have to look at each company's ability to maintain margins. For instance, Coca-Cola has historically been able to pass on cost increases without losing volume. That's why it's holding up better than Altria, which faces declining volumes and regulatory headwinds. Luna: So what's the one metric you'd tell our listeners to check tonight when they look at their dividend holdings? Lucas: Free cash flow coverage — that's the dividend divided by free cash flow. If it's below sixty percent, you're probably safe. If it's above eighty percent, you need to worry. And remember, this is a dynamic number, so check it every quarter. Luna: That's a simple, actionable rule. I'm going to write that down. Lucas: And while you're looking at that, also check the company's debt maturity schedule. If they have a lot of debt coming due in the next few years, they might have to refinance at higher rates, which could pressure future dividend growth. Luna: So the takeaway isn't 'sell all dividend stocks,' it's 'be more discerning about which ones you own.' Lucas: That's exactly right. And as the curve continues to steepen — and we think it might, if the Fed holds and the economy stays resilient — these distinctions will only matter more. Luna: Great. That gives us a lot to think about. Thanks for breaking this down, Lucas. Lucas: Anytime. We'll keep watching the curve and bring you more insights. Until next time, keep an eye on that free cash flow.