Goldman Sachs just shattered a myth about how higher rates affect stocks
- A widely-accepted tenet of stock investing is that so-called "yield proxy" stocks falter in an environment where interest rates are rising.
- To the contrary, Goldman Sachs argues there's a segment of the high-yielding stock universe that should stay resilient in the face of rate hikes.
It's conventional wisdom that when interest rates rise, investors should steer clear of stocks with high dividend yields.
The logic is simple: rising rates make the yields offered by equities less attractive by comparison. And since those stocks rely so heavily on their appeal as so-called "yield proxies," any competition can lead to selling.
While Goldman Sachs acknowledges this dynamic is true to a degree, it also argues stock gains can still be found among high dividend payers - as long as investors know where to look.
To Goldman, the key is not how much these stocks are paying in dividends, but how quickly they're growing that yield. By their measure, the top 25% of dividend growers in the S&P 500 have actually outperformed during past rising-rate environments.
"With the spectre of rising rates, we expect that dividend growth stocks will be relatively more immune," Goldman analyst Jessica Binder Graham wrote in a client note. "We find that the high dividend growth stocks not only outperform high yield, low growth stocks during rising rate environments ... but also continue to outperform the broader index."
This is an important discussion to be having right now, considering the Federal Reserve is expected to raise interest rates three times in 2018, with more hawkish commentators calling for four hikes. In a written testimony released Tuesday morning, Fed Chairman Jerome Powell did nothing to shift these expectations.
"Some of the headwinds the US economy faced in previous years have turned into tailwinds," said Powell. "Fiscal policy has become more stimulative and foreign demand for US exports is on a firmer trajectory.''
As income investors - or traders who seek yields such as those provided by dividends - await further signals from Powell and the Fed, they can rest easy knowing there's at least one segment of their universe that should stand tall as rates rise.