This is a Guest Post by Tom Hutchinson, Chief Analyst, Cabot Dividend Investor
Published on October 3rd, 2024
For most of the last two years, the market was driven higher by technology stocks while the rest of the market posted lame returns.
But that dynamic has been reversing. For the last three months, technology has been the worst-performing of the 11 S&P 500 sectors with a -0.21% return while the S&P is up 5.53%.
The best-performing sectors of the last three months are Utilities (18.55%) and Real Estate (16.30%), the worst-performing sectors for much of the last two years. The reason for the shift is interest rates.
Interest rate-sensitive sectors suffered as rates rose to the highest levels in decades. To combat the worst inflation in 40 years, the Fed raised the Fed Funds rate from near 0% to 5.25% to 5.50% from February of 2022 to July of 2023, where it remained until this week.
The benchmark 10-year Treasury rate soared from 1.4% at the beginning of 2022 to 5% by October of 2023.
But the interest rate narrative is changing.
The inflation rate has come way down and the main risk to the market is recession, not rising rates. The 10-year Treasury has come down from 5% last October to 3.80% now.
The Fed began cutting rates last month with a 0.50% cut. While there is speculation over the future pace of rate cuts, the cutting process has begun and will continue through the next two years at least.
In times of falling interest rates, income investors should consider high dividend stocks.
The free high dividend stocks list below has ~230 individual securities (stocks, REITs, MLPs, etc.) with 5%+ dividend yields:
Falling rates and anticipation of future declines have ignited utility stocks. The Utilities Select Sector SPDR Fund (XLU), a sector bellwether, has rallied more than 18% since the end of June and 27% since the end of February, compared to returns of 5.5% and 9.7% for the S&P 500 over the same periods, respectively.
Utilities have been the single best-performing S&P sector year to date with a 27.5% return.
The utility stock rally may not be over. The sector underperformed the S&P by 34% in 2023, when the XLU returned -7% and the S&P was up 27%. In fact, XLU has significantly underperformed the market for the past five-year, three-year, and one-year periods. Many individual utility stocks are still trading well below the all-time high while the S&P hit a new high this week.
Utilities are the most bond-like stock sector with high yields and slow growth. The direction of stock prices often mimics that of the bond market. Over the last 40 years of trading history during Fed cycles, only about half the bond rally has occurred by the first Fed rate cut. It’s also important to consider the current state of the market and economy.
There is increasing worry about a recession in the quarters ahead. Perhaps it’s overblown. We may indeed get a soft landing. But recession or not, utilities have a long track record of market outperformance during slowing economies and recession because of the highly defensive nature of their earnings.
The market is near an all-time high while it is likely to be an environment of falling interest rates for the next two years. Falling interest rates and a slowing economy are the ideal backdrop for utility stock performance. And many of these stocks are still cheap with high yields and newfound momentum.
With all of that in mind, here is a high-yield utility stock to play the new rate-cutting environment.
High Yield Stock: Brookfield Infrastructure Corporation (BIPC)
- Dividend Yield: 3.7%
BIPC is stock representing shares in the same entity as the original Brookfield Infrastructure Partners (BIP), except that instead of a Master Limited Partnership BIPC is in the form of a regular corporation.
Bermuda-based Brookfield Infrastructure Corporation owns and operates infrastructure assets all over the world. The company focuses on high-quality, long-life properties that generate stable cash flows, have low maintenance expenses and are virtual monopolies with high barriers to entry.
Infrastructure is defined as the basic physical structures and facilities needed for the operation of a society or enterprise. It includes things like roads, power supplies and water facilities. Not only are these some of the most defensive and reliable income-generating assets on the planet but infrastructure is rapidly becoming a timelier and more popular subsector.
As one of the very few tested and tried hands, Brookfield is right there. It’s been successfully acquiring and managing these properties for more than a decade in a way that delivers for shareholders.
Since its IPO in 2008, the original BIP has provided a total return of 821% (with dividends reinvested) compared to a return of 449% for the S&P 500 over the same period. And those returns came with considerably less risk and volatility than the overall market.
Brookfield operates a current portfolio of over 1,000 properties in more than 30 countries on five continents. The company operates four segments: Utilities (30%), Transport (30%), Midstream (30%) and Data (10%).
The dividend is rock solid with a low 70% payout ratio and a history of steady growth, The payout has grown by a CAGR (compound annual growth rate) of 10% per year since 2009 and the company is targeting 5% to 9% annual growth going forward.
While long-term performance has been great, this dividend-paying stock has struggled amid the high-interest-rate environment. It returned -19% over 2022 and 2023.
But that’s changed in 2024, with the stock up 23% through the first nine months of the year, and rising fast since it became clear that the Fed was about to start cutting rates, racing to 52-week highs.
BIPC, after two down years, has all the makings of becoming a big winner in a falling-rate environment.
Additional Reading
See the resources below for more compelling investment ideas for dividend growth stocks and/or high-yield investment securities:
- Dividend Kings: 50+ years of rising dividends
- Dividend Champions: 25+ years of rising dividends
- Dividend Aristocrats: 25+ years of rising dividends and in the S&P 500
- Dividend Achievers: 10+ years of rising dividends and in the NASDAQ
- Blue Chip Stock: Kings, Aristocrats, and Achievers
- MLPs: List of MLPs and more
- REITs: List of REITs and more
- BDCs: List of BDCs and more