8 Jul

Why Do Dividend Stocks Sometimes Behave Like Bonds?

WRITTEN BY Sanmit Amin

Sectors with dividend-paying stocks

Dividend-paying stocks usually belong to sectors that are mature and have steady but slow earnings growth. Companies with more volatile earnings and in more economically sensitive sectors usually have lower dividend yields.

“Beta” is a measure of a fund’s sensitivity to market movements. If a stock has a beta of 1.2, it could perform 20% better than the S&P 500 in up markets and 20% worse in down markets. Similarly, a stock with a beta of 0.9 indicates that the stock is expected to perform 10% worse than the market’s return during up markets and 10% better during down markets.

Sectors that are defensive in nature usually have a beta of less than 1, while the betas of cyclical companies are generally higher than 1.

Why Do Dividend Stocks Sometimes Behave Like Bonds?

Dividend stocks tend to be stabler

The graph above shows the beta for utilities (IDU), REITs (VNQ), and telecom companies, considering weekly returns over the past two years. All three sectors have betas well below 1. Utilities (XLU) have the lowest beta out of the three sectors. REITs, however, are usually considered cyclical.

Dividend stocks have some bond-like characteristics. Firstly, since dividend stocks tend to be defensive in nature, they give you a cushion during risk-off scenarios while underperforming during risk-on scenarios. Secondly, they offer regular income in the form of dividends or coupons.

Why Do Dividend Stocks Sometimes Behave Like Bonds?

Dividend stocks behave like bonds

The second graph in this post shows the correlation of various sectors with the iShares Barclays Aggregate Bond ETF (AGG), which is used as a proxy for investment-grade bonds in the United States. The data above considers weekly returns for the past ten years. The correlation coefficient always lies between -1 and 1.

The S&P 500 (SPY)(IVV) has a correlation of +0.11 with bonds. The utility sector has a higher correlation of +0.28. The telecom and consumer staples sectors have respective correlations of +0.21 and +0.17 with AGG, which are higher than the correlation between AGG and SPY.

So, as interest rates rise, dividend stocks are likely to underperform the S&P 500 along with bonds.

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