Are rising rates problematic for dividend investors? Portfolio manager Jim Lovelace, an equity-income investor, shares what he expects in today’s environment.
American Funds video transcript: “Dividend investing when rates are rising”
Apu Sikri: Jim, you are an equity-income investor. Interest rates have been inching higher. The 10-year has hovered between 2.75% and 3%. What does that mean for dividend-paying and dividend-growing stocks and dividend-oriented strategies?
Jim Lovelace: Rising interest rates tend to be challenging for income-oriented portfolios, because a lot of the sectors that income investors invest in are very sensitive to what the current bond rate is — in particular, the slower growing, highly regulated industries such as telecommunications, electric utilities. And also the financial sector tends to be very sensitive to interest rate movements. So, it can be more challenging for income portfolios when interest rates are rising.
Apu Sikri: Stocks have continued to trend higher even as rates have been rising in the U.S. So, how are you thinking about this environment?
Jim Lovelace: Well, stocks overall are not necessarily harmed by rising interest rates. And in fact, it's important to understand that the main driver for rising interest rates is strong economic activity. And that can be helpful to corporate profits. So, in the early stages of an expansion, often you'll see rising interest rates and rising stock prices, and also perhaps in the mid-cycle.
It's only toward the end of a cycle, when there are excesses beginning to build up and the Federal Reserve is trying to slow things down, [that] interest rates can have a negative impact on stock prices. Folks always remember that — those last Fed hikes, as it were, that end up ending a cycle, and then they become somewhat worried when interest rates begin to rise. But interest rates rising most of the time simply means that the economy is strong and perhaps gaining momentum.
Apu Sikri: What signals do you think the market is giving us in terms of rising rates? Is it that the economy continues to strengthen? What are your views on that?
Jim Lovelace: As you mentioned with the 10-year bond rate around 3% [or] thereabouts, when you look at history, that’s a fairly modest rate for long-term rates such as the 10-year. So, it isn't signaling to me that there are excesses or that the Fed is trying to stop the economy or slow down inflation. Probably rates would have to get up into the 4–5% range to be problematic. So, I don't see interest rates rising modestly from here as being a great impediment to the stock markets.
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