Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend Investors Can Profit From the Yield Curve Steepener
Transcript
- Lucas: Look at the numbers on the desk right now. The ten-year Treasury is sitting at 4.79 percent, but the three-month bill is only at 3.92 percent. That is a forty basis point spread where there was essentially zero spread just a few months ago. We used to talk about the curve being deeply inverted, which punished every single dividend payer because their cheap short-term debt suddenly became expensive overnight. Luna: Exactly, and that inversion was the silent killer for companies relying on commercial paper to fund dividends. Now that the curve is flipping positive, the cost structure for those same companies is changing in a completely different direction. Lucas: Right. So here is the angle I want to drill into today. When the curve steepens, it signals that the market expects growth and potentially higher inflation further out. But for a dividend investor, the immediate mechanical effect is that short-term borrowing costs drop relative to long-term bond yields. This creates a weird arbitrage opportunity for companies with huge floating-rate debt, but it also raises the hurdle rate for new capital expenditures. We need to look at how giants like Johnson & Johnson and Procter & Gamble are navigating this specific window in September 2026. Luna: I have been watching the healthcare sector closely because JNJ just posted a solid move, up nearly four percent over the last five days. Does that rally reflect the changing rate environment, or is it just general market noise? Lucas: It is definitely not just noise. JNJ has a massive balance sheet, but they also carry significant long-term fixed-rate debt issued when yields were near zero. As the ten-year yield climbs toward 4.80 percent, the value of that old cheap debt becomes even more precious. It locks in a low cost of capital while the broader economy faces higher short-term rates. This gives them pricing power and margin stability that newer entrants do not have. They are effectively subsidizing their dividend sustainability with legacy balance sheet advantages. Luna: That is a great point about legacy debt. But what about companies that rely heavily on refinancing their maturing bonds right now? If the ten-year is stuck above 4.75 percent, their new interest expense could eat directly into free cash flow. Lucas: You are hitting on the exact tension in the market. Let us take Procter & Gamble as the counter-example. PG is up over three percent recently, and their stock price is hovering around 147 dollars. They are a master of cash flow generation, but they are not immune to this. When the curve steepens, it often means the Federal Reserve is holding steady while long-term expectations rise. For P&G, this means they cannot easily refinance short-term obligations without locking in higher long-term costs if they choose to extend maturity. They have to be surgical about their debt ladder. Luna: So they are prioritizing operational efficiency over aggressive expansion to protect that payout? Because if they expand too fast into a higher-cost environment, the return on invested capital might not justify the debt service. Lucas: Precisely. Return on invested capital is the metric that matters now, not just revenue growth. If a company borrows at 5 percent to build a factory that only yields 4 percent operating profit, they are destroying shareholder value. In a steepening curve environment, smart CFOs freeze large capex projects unless the internal rate of return clears that new, higher hurdle. This actually benefits dividend investors in the long run because it prevents reckless over-leveraging. Luna: It feels like we are seeing a divergence between companies that hoarded cash during the pandemic and those that levered up. Which group is better positioned for this specific 4.79 percent ten-year yield scenario? Lucas: The cash-rich groups are winning hands down. Look at the Real Estate Investment Trusts. O, which is Realty Income, is trading flat today at 61.50 dollars. REITs are notoriously sensitive to interest rates because their entire business model is based on leveraging cheap debt to buy assets. When the ten-year yield is 4.79 percent, their cost of capital spikes immediately. They have to offer higher yields to attract tenants and investors, which compresses their margins. They are currently pausing growth, waiting for clarity on whether these long-term rates are permanent. Luna: But wait, didn't New York Fed President Williams just say yesterday that the yield surge is due to strong economic prospects rather than inflation panic? That sounds like good news for equities overall. Lucas: He did say that, and it is a crucial distinction. If yields are rising because the economy is growing robustly, then corporate earnings can keep pace with higher interest expenses. That is bullish for broad indices like the S&P 500, which is still up slightly despite the volatility. But for dividend purists, it means we have to dig deeper into quality. A rising yield driven by growth optimism is safer than one driven by inflation fears, because inflation erodes the real value of future dividend payments. Growth allows companies to raise dividends nominally, preserving purchasing power. Luna: So we should favor companies with strong pricing power over those with just stable demand? Like tobacco or utilities, where they can pass costs onto consumers regardless of the rate environment? Lucas: Absolutely. Consider Altria, or MO. It is up nearly three percent recently, trading around 69 dollars. Tobacco companies have incredible pricing power because demand is inelastic. Even if their borrowing costs rise, they can simply raise cigarette prices, and customers will still buy. This makes their cash flows incredibly predictable, which supports the dividend even when the macro backdrop gets messy. It is a classic defensive play in a steepening curve. Luna: That makes sense. Inelastic demand acts as a shield against margin compression. But what about the tech sector? Are any dividend payers in technology benefiting from this shift? Lucas: Tech is tricky because most high-growth tech firms do not pay meaningful dividends yet. However, mature tech players like Microsoft and Apple are starting to lean heavier into buybacks and special dividends. But here is the catch: in a steepening curve, buying back stock becomes more expensive if they have to issue new debt to fund it. So they are shifting toward using existing cash piles. This preserves their balance sheet strength for potential M&A activity later, which is something we are already seeing hints of from Berkshire Hathaway's Greg Abel regarding international opportunities. Luna: Greg Abel mentioned Japanese bond yields not being a challenge for trading houses. Does that global perspective matter for our us focused dividend portfolios? Lucas: It matters more than you might think. Global capital flows are interconnected. If Japanese yields remain suppressed while US yields rise, capital flows into the US, strengthening the dollar. A strong dollar hurts multinational corporations like Coca-Cola, which is down nearly one percent today at 88 dollars. Their overseas earnings convert to fewer dollars, squeezing reported profits. So even if their dividend is safe, the currency headwind makes the total return less attractive compared to domestic-only dividend payers. Luna: Currency risk is another layer we rarely discuss when talking about pure yield. It really highlights why domestic focus might be prudent right now. Lucas: It does. And let us pause here for a moment. If these conversations about reading the curve and protecting your cash flow have helped you rethink your portfolio allocation, the way these stay ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo. It helps us keep digging into the data so you don't have to guess. Luna: Yeah, and honestly, it keeps us from having to chase hot takes. We prefer to just show up with the spreads and the balance sheets every single day. Lucas: Thanks for that. Now, back to the mechanics. We have established that steepening favors companies with low-cost legacy debt and pricing power. But there is a second-order effect that most investors miss. It involves the interaction between dividend policy and share count management. Luna: Share count management? You mean buybacks? I thought you said buybacks were getting expensive? Lucas: They are, which is why the trend is shifting. In a flat or inverted curve, companies would borrow cheaply to buy back shares, boosting EPS artificially. In a steepening curve, that arbitrage disappears. Companies are now letting share counts stabilize or even grow slightly as they prioritize organic R&D and maintenance capex. This sounds negative, but it is actually healthier. It means earnings growth must come from actual product sales, not financial engineering. For a long-term holder, this reduces the risk of a sudden earnings collapse when the debt matures. Luna: So we are moving from a era of financial engineering back to an era of operational fundamentals. That feels like a correction we needed after the zero-rate decade. Lucas: Exactly. And this brings us to Verizon, VZ. It is up 1.6 percent recently, trading at 50 dollars. Telecoms are heavy infrastructure plays. They have enormous upfront capital needs for network upgrades. When the ten-year yield is 4.79 percent, the cost of building that network goes up significantly. Verizon has to be very careful about how much debt they add. If they over-leverage to maintain their high yield, they risk credit downgrades. But if they cut the dividend, the stock crashes. It is a delicate balancing act. Luna: That is the tightrope walk. High yield plus high capex plus rising rates is a dangerous combination. How do we spot which telcos are managing this well versus those who are stretching themselves thin? Lucas: Look at the FCF payout ratio. If a company is paying out more than 80 percent of its free cash flow as dividends, and it has high capex requirements, it is in danger zone territory in this environment. Verizon has been gradually lowering its payout ratio to match its cash flow growth. This conservative approach suggests they are prioritizing sustainability over headline yield. In a steepening curve, safety is the only premium that matters. Luna: So headline yield is becoming less important than payout coverage and balance sheet health. That changes the screening criteria entirely. Lucas: It does. You have to filter for companies with maturities staggered away from the current peak rate environment. If a company has no major debt maturities until 2028 or 2029, they are insulated from today's 4.79 percent ten-year. They get to enjoy the current stability without the refinancing shock. We see this in many utility companies, though utilities face their own regulatory risks. It is a nuanced landscape. Luna: Regulatory risk adds another variable. If a utility raises rates to cover higher interest costs, regulators might block it, squeezing their margin. That is a double whammy. Lucas: Correct. Which is why I am leaning towards industrial conglomerates or diversified holdings. Think about General Electric or similar structures. They operate across multiple sectors, so if one sector suffers from high rates, another might benefit from inflationary pricing power. Diversification within the equity portfolio acts as a hedge against the specific distortions caused by the steepening curve. Luna: It reminds me of the old advice to not put all your eggs in the yield basket. Especially when the basket itself is being shaken by monetary policy shifts. Lucas: Spot on. And let us not forget the small-cap index, the Russell 2000, which is down two percent recently. Small caps are almost entirely reliant on floating-rate debt. A steepening curve is brutal for them because their short-term rates rise immediately. They are not generating enough cash flow to absorb the hit. This reinforces the idea that for dividend income, you want scale. Large caps have access to the long-term bond market; small caps are stuck in the short-term pool. The gap between them is widening rapidly. Luna: So the flight to quality is not just a buzzword, it is a mathematical necessity in this rate environment. Quality means access to cheaper, longer-dated capital. Lucas: Exactly. Quality means longevity. And as we look ahead, the key question is whether the ten-year yield stays anchored near 4.80 percent or continues to climb. If it breaks above 5 percent, we will see a significant re-rating of all dividend stocks. Those with weak balance sheets will get hammered. Those with fortress balance sheets will hold steady and potentially gain market share. Luna: It puts a premium on patience. Waiting for the dip in weaker names to buy stronger ones, rather than chasing yield blindly. Lucas: Patience and precision. The curve is steepening, the Fed is watching, and the markets are adjusting. Your job is to identify which companies are adapting and which are lagging. Focus on the coverage ratios, the debt maturity walls, and the pricing power. Ignore the headline yield and watch the cash flow. Luna: Because ultimately, a dividend paid from sustainable cash flow is worth infinitely more than a high yield paid from borrowed money. Lucas: Well said. We will keep tracking the ten-year and the corporate balance sheets. See you next time.