Dividend-paying stocks face a major headwind in this current climate due to rising long-term interest rates. In August, the yield on the 10-year hit 0.5%, while the stock market was making new, all-time highs.

Earlier this week, the 10-year Treasury yield hit a high of 1.19%. This rebound in rates is primarily due to expectations that growth will accelerate in the second half of 2021. The move has also been supported by election outcomes which favor larger amounts of fiscal stimulus in the coming months. Higher deficits increase the supply of Treasuries which puts upward pressure on rates.

Dividend stocks tend to underperform during periods of rising rates as their income streams become marginally less attractive. A dividend payment of 4% is more appealing when interest rates are at 0.5% rather than 3.5%. 

Characteristics of Dividend Outperformers

This doesn’t mean that investors should disregard all dividend stocks, but it does mean they should be more judicious when making selections and manage risk more carefully. Certain dividend stocks are likely to keep outperforming despite rising rates.

Investors should look at sectors that will benefit from these economic and financial conditions. A shorthand is to look at the last period in which we had rising rates, high deficits, and dovish monetary policy – this would be the bull market from 2003 to 2008 – which followed the dot-com bubble.

During this period, hard assets outperformed. Value stocks also did well, while growth stocks underperformed. Other outperformers included real estate, financials, energy, materials, and industrial stocks. Income-oriented investors should look to those sectors to find dividend stocks as increases in earnings will offset the headwind of rising rates. Three dividend stocks in this category are  Annaly Capital (NLY), Antero Midstream (AM), and Tangers Factory Outlet Centers (SKT).

Annaly Capital (NLY)

NLY is a REIT that invests in various mortgage-backed securities for residential and commercial properties. It’s more than doubled from its March lows due to strength in real estate and the steepening of the yield curve.

The company has a bright outlook. The combination of loose monetary policy and aggressive fiscal policy should be a positive environment for hard assets like real estate. Further, household balance sheets are in good shape implying that default rates should remain low. Most analysts are projecting GDP growth above 5% in the latter half of 2021 which is also supportive of a strong housing market. 

NLY has a 10.5% dividend yield. It’s quite cheap with a price to book value under 1. Finally, earnings should start to rise given that short-term yields are going to remain at zero until 2022, while long-term rates are rising. Currently, the stock has a forward price to earnings ratio of 7.8.

The POWR Ratings are bullish on NLY as well. It has a Buy Rating with an “A” for Trade Grade and Peer Grade with a “B” for Buy & Hold Grade. Among REITs – Mortgage, it’s ranked #4 out of 31.

Antero Midstream (AM)

AM owns and operates midstream energy assets. The stock has been mired in a bear market due to weakness in natural gas prices. However, there are some compelling reasons to believe that natural gas prices will continue their ascent which would result in AM’s price continuing its rise as well.

Natural gas prices have been depressed since 2011 due to the increase in shale production. Natural gas is a byproduct of shale oil drilling to an extent that much of it is burned at the source. The bear market and sudden plunge in oil prices have resulted in most shale projects being turned off. Turning them back on requires a significant amount of capital. It’s unlikely that shale production would return to pre-coronavirus levels until oil prices can sustain themselves above $70 for a long period.

The poor conditions for natural gas also resulted in underinvestment for nearly a decade. This means there are no new imminent sources of production if prices do rise. Demand for natural gas has remained stable during the coronavirus and will return to its pre-coronavirus trajectory when the economy reopens.

AM also has a 14.5% dividend yield. It’s managed to make payments through a brutal climate for natural gas. Now, conditions are improving. The POWR Ratings also share this bullish outlook for AM as it has a Strong Buy rating. It has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade.

Tangers Factory Outlet Centers (SKT)

There are many reopening stocks like airlines, hotels, or cruises where there is a greater deal of certainty about their prospects when the economy reopens. However, a riskier category is retail. Even before the pandemic, retail stores and REITs were struggling as more shopping was going online. Of course, this trend was exacerbated by the coronavirus.

I believe that we are going to see in-store traffic to physical stores rebound massively. Even despite the pandemic, it’s remained remarkably resilient. The pandemic will lead people to appreciate the benefits of shopping in stores. Due to pessimism and low expectations, these stocks have cheap valuations and high short interest. This combination could lead to big gains as spending in retail stores explodes in the second half.

Among Retail REITs, SKT is particularly attractive since it is exposed to outlet stores which is one segment of retail that was strong pre-pandemic. People love shopping at outline stores, and it gives companies an outlet for their merchandise. 

The POWR Ratings are also bullish on SKT as it has a Buy rating. It has a “B” for Trade Grade and Peer Grade. Among REITs – Retail, it’s ranked #13 out of 41.

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NLY shares were unchanged in after-hours trading Friday. Year-to-date, NLY has declined -1.89%, versus a 0.49% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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