Rate Shock for High-Yield Stocks?

US stocks with high dividend yields are looking very risky these days. Investors with too much exposure to sectors such as utilities and telecom may be in for a shock if interest rates eventually begin to rise.

In today’s low-interest-rate environment, many investors are desperately seeking yield. In equities, flows to high-dividend sectors—such as utilities, telecom and consumer staples—have stretched valuations and inflated those sectors’ weightings in indices such as the S&P 500 Index. We believe that crowded trades like these are very risky, and there are already signs that they are starting to unwind.

Yield chasers should also think about interest-rate risk. Our research shows that the correlations of returns in these yield-centric sectors with the 10-year US Treasury rate have risen substantially over time (Display). Since the Fed’s “taper tantrum” in May 2013, returns for utilities, telecom, consumer staples and REITs are much more tightly synchronized with the Treasury rate than over the last five- and 10-year periods.

Several Fed officials recently signaled that a rate hike is likely “relatively soon,” according to minutes released this week from the US central bank’s September policy meeting. If rates begin to rise, investors who are overweight high-yielding equity sectors in a balanced portfolio containing fixed income might not be as diversified as they think.

© AllianceBernstein