The long term outlook for dividend growth stocks in a rising interest rate environment

Stock Market Outlook

In our recent Strategy Notes, we said that we were hopeful that we could see some very satisfactory gains over the next year in the TSX since we viewed our previous target of 16,000 for the TSX as very conservative as it was based on an oil price in the low $50s. Our conviction is growing stronger that global oil inventories will fall below their five-year average by the middle of 2018. If this proves to be the case, the oil price would handily surpass the $60 level and possibly the $70 level. That would mean, in our view, a TSX target of at least 17,000 in 2018 and a reversion to outperformance by the TSX relative to the S&P 500 such as we enjoyed in 2016 but have not experienced this year.

Several clients have asked us of late about our view that long term interest rates have likely bottomed on a secular basis and wondered whether a rising rate environment would be negative for dividend paying stocks. We contest this view and this Strategy Note will examine the historical data for dividend payers and their performance in a rising rate environment.

The long term outlook for dividend growth stocks in a rising interest rate environment

In our November 1 Strategy Note, we commented on the longer term outlook for interest rates. In sum, we felt that there were various forces at work, which would keep inflation lower than the Fed believed and most investors believed. We concluded that we do not see a sharp acceleration in inflation in North America as being very likely. Consequently, we suspect that although short and long term rates could rise somewhat, we suspect that the increase will be  lot less than central banks and investors generally believe. That is still our view. However, what we did not restate then is our previously expressed view that we think it is likely that the 35 year bull market in bonds (and bear market in yields) which started in 1981 is likely over. We peg the bottom of the U.S. 10-year Treasury yield cycle at 1.37% in July 2016. The subsequent rally in rates took the yield to just over 3% last year but it has since declined to a current level of 2.37%.

Several clients have noted that dividend stocks have done exceedingly well since the Financial Crisis and so, if long term interest rates have indeed bottomed, then possibly dividend stocks would not do so well in the coming years, especially if we were embarking on a long term secular bear market in bond prices with rising yields.

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