The case for defensive dividend payers is strong right now The case for defensive dividend payers is strong right now http://www.federatedhermes.com/us/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedhermes.com/us/daf\images\insights\article\hot-air-balloon-valley-small.jpg December 4 2024 December 4 2024

The case for defensive dividend payers is strong right now

One reason is rate cuts.
Published December 4 2024
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Defensive stocks in the high-dividend-paying sectors of the market offer a compelling combination of characteristics right now including, unlike some sectors of the market, attractive valuations. The S&P currently stands at a P/E multiple of 26 versus a multiple of 20 over the past decade. By contrast, the Dow Jones Select Dividend Index currently stands at 14.

Adjusted for business cycles, overall equity market valuations are near record highs, with an average cyclically adjusted P/E ratio of 38 versus an average 23 since 1980, according to Robert Schiller. These high valuations are driven primarily by stocks in the Info Tech sector, which is about 30% of the S&P 500.

This high concentration of large growth stocks and their high valuations poses a risk. In a sell-off, these stocks are likely to take the largest hit, as they did in 2022. To defend against these risks, and diversify from large growth, consider defensive dividend stocks. We particularly like Utilities.

Defensive sectors are the dividend-fertile areas of the market: Telecommunications, Energy, Real Estate, Utilities and Consumer Staples. Combined, these five sectors make up less of the S&P 500 by market cap than Tech, offering diversification from large growth. They also offer attractive income potential, lower volatility, and, in some cases, like Utilities, growth potential.

After being out-of-favor and underperforming significantly since 2023, dividend names bounced back this summer as growth stocks sold off. Since then, growth stocks have rebounded, but we believe the long-term rotation has legs.  

With more rate cuts ahead, investors may need to seek alternative sources of income. In addition to income, high-dividend payers also offer upside potential because they are more rate sensitive than low or non-payers. This rate sensitivity is one reason why defensive, dividend-paying sectors have outperformed in the six months after initial rate cuts in the last four cycles, where Utilities, Consumer Staples and Health Care have led and Consumer Discretionary, Real Estate and Information Technology have lagged.

Utilities are especially rate-sensitive because of the nature of their businesses, which are more capital-intensive and require more debt. Now, Utilities stocks also have the benefit of long-term growth potential, driven by the increasing adoption of artificial intelligence (AI) technologies, which require significant energy for data processing. There are additional reasons why Utilities should see future growth. Current US infrastructure cannot sustain the clean energy transition, onshoring of manufacturing and decades of underinvestment. Further, due to geopolitical risk, the US needs to harden the grid. As a result, Utilities are building both the generation capacity to support load growth and the transmission infrastructure to ensure the reliability of the grid. We’re seeing Utilities companies accelerate capital expenditure (capex) plans, driving more sales and capex, and extending their earnings-per-share and dividend-per-share growth outlooks.

Near-term too, a combination of improving fundamentals and the valuation backdrop should support Utilities’ performance more broadly into first half of 2025 as lower Inflation, any future rate cuts, and rising electricity demand would be near-term tailwinds.

In sum, we believe the risk-reward ratio is stacked favorably for defensive dividend stocks as we head into 2025.

 

Tags Equity . Interest Rates .
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Price-Earnings Ratio is a valuation ratio of a company's current share price compared to its per-share earnings.

Stocks are subject to risks and fluctuate in value.

Diversification does not assure a profit nor protect against loss.

There are no guarantees that dividend-paying stocks will continue to pay dividends. In addition, dividend-paying stocks may not experience the same capital appreciation potential as non-dividend-paying stocks.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Dow Jones U.S. Select Dividend Index: Universe is defined as all dividend-paying companies in the Dow Jones U.S. Total Market Index that have a non-negative, historical, five-year dividend-per-share growth rate, a five-year average dividend earnings-per-share ratio of less than or equal to 60% and three-month average daily trading volume of 200,000 shares. Current index components are included in the universe regardless of their dividend payout ratio.

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