Exchange-traded funds that focus on high-yielding sectors such as utilities, energy, and commodities have outperformed the broader market.
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High-yielding stocks have been standout performers this year and could be poised for more gains, according to Bank of America.
Investors should “double down” on dividend yields this year, said Savita Subramanian, head of U.S. equity and quantitative strategy at BofA, in a research note published Wednesday.
Subramanian and her team outlined six reasons why investors should focus on yield. One is that we’re now in a “total return world” with gains more likely to come from dividends than price appreciation. BofA’s year-end target for the S&P 500 is 4,600, implying a negative 4.2% price return from the start of 2022—the first down year for the index since 2018.
Dividends have historically made up 36% of the market’s total returns, and they could be poised to pick up the slack in prices now.
Stocks with relatively high yields are also known as “short duration” equities, as opposed to growth stocks that are long-duration. Growth has been hammered this year as investors price in higher bond yields, which reduce the present value of future cash flows for high-growth companies especially hard.
Dividend yields are low by historic standards, implying they are likely to increase. The yield on the S&P 500 is 1.3%, one of the lowest yields in history going back to 1953, BofA says.
Moreover, rising dividend yields offer inflation protection, something that investors will likely want with inflation recently at an 8% annualized rate. Sectors that have outperformed this year are those benefitting from inflation, including energy and materials.
Indeed, the macro backdrop has made dividends even more valuable with the Federal Reserve poised to raise rates at the fastest pace since the early 2000s. Against that backdrop, “bird in the hand” stocks with relatively high yields will likely keep outperforming, BofA says. They also tend to outperform during late-cycle periods of economic growth and market performance–the current environment.
How to invest? Exchange-traded funds that focus on high-yielding sectors such as utilities, energy, and commodities have outperformed the broader market this year. Choices include the Utilities Select Sector SPDR Fund (ticker: XLU), Energy Select Sector SPDR Fund (XLE), and WisdomTree Enhanced Commodity Strategy Fund (GCC).
XLU yields 2.9% while XLE is at 3.8%. GCC has a 7.7% distribution yield, according to WisdomTree .
Others to consider include the Vanguard High Dividend Yield ETF (VYM), Global X MLP ETF (MLPA), and Global X SuperDividend U.S. ETF (DIV). VYM yields 2.7%, MLPA yields 8.1%, while DIV pays 5.2%.
Bear in mind that high yields don’t guarantee positive total returns. Investors have already bid up sectors such as energy and commodities sharply. Additional price gains will likely be lower. Investors in high tax brackets should also consider placing income-oriented ETFs in a tax-efficient retirement account like an IRA.
Write to Daren Fonda at [email protected]
