The stock market’s recent volatility has been akin to a roller coaster ride, leaving investors feeling unsettled. This turbulence serves as a crucial reminder of the importance of maintaining a diversified portfolio, particularly one that includes safer assets like dividend-paying companies, which offer a steady and reliable income stream.
Over the past two weeks, as the market experienced significant swings, certain sectors have emerged as clear winners. Real estate investment trusts (REITs) have been the top performers since the end of June, rallying 9%. Utilities followed closely with an 8.8% gain, and financials rounded out the top three with a 5.7% increase. These sectors have benefited from the drop in long-term bond yields and the resulting stock market turmoil.
Nicholas Colas, co-founder of DataTrek Research, pointed out that REITs and utilities are considered “bond substitutes,” which means they tend to rally when interest rates drop sharply. Additionally, banks benefit from lower short-term rates, making the financial sector another strong performer.
The 2-year U.S. Treasury yield, which influences bond prices, fell from about 4.34% at the end of July to around 3.65% in early August, before recovering to approximately 4.1%. This inverse relationship between bond prices and yields has driven investors towards sectors that offer relatively high dividend yields. For example, the Real Estate Select Sector SPDR ETF has an average dividend yield of 3.3%, while the Utilities Select Sector SPDR ETF offers a yield of 3%.
Utilities have also gained attention due to their involvement in the artificial intelligence (AI) wave. Nuclear energy, in particular, is crucial for powering data centers, and companies like Constellation Energy and Vistra have been among the top performers in the S&P 500 this year. As a result, the utilities ETF has slightly outperformed the tech-heavy Invesco QQQ Trust, which tracks the Nasdaq-100 index.
Investors are also gravitating towards utilities with higher dividend yields, such as Edison International, Dominion Energy, and Duke Energy, which offer yields approaching 4% to 5%. Financials, including JPMorgan Chase, Goldman Sachs, and Bank of America, also provide attractive yields above 2%.
These sectors are generally considered defensive, meaning they tend to perform better during periods of market volatility and economic uncertainty. With questions lingering about the U.S. economy’s underlying strength and the Federal Reserve’s future policy moves, these high-yielding sectors could continue to outperform the broader market in the coming weeks.
However, the recent market chaos has subsided somewhat, with the Cboe Volatility Index (VIX) settling back to mid-teen levels after spiking above 65 on August 5. Despite this, strategists at Ned Davis Research caution that after such VIX shocks, utilities, REITs, and materials stocks often underperform the broader market over the following six to 12 months.
That said, investors shouldn’t abandon dividend-paying stocks altogether. The same research found that healthcare and consumer staples stocks tend to outperform in the year following a VIX surge. Other sectors, including consumer discretionary, energy, tech, and communications services, also perform well, and many companies in these sectors pay dividends.
Even though their yields may be lower than those of utilities and REITs, tech giants like Apple, Microsoft, Nvidia, Meta Platforms, and Alphabet all issue dividends. This means that income-seeking investors don’t necessarily have to avoid momentum growth stocks entirely. Notably, Tesla and Amazon.com are the only two of the “Magnificent Seven” tech stocks that don’t offer dividends.
As the market continues to navigate these uncertain times, investors would do well to remember the value of diversification and the steadying influence of dividend-paying stocks.
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