A Good Time For Steady Dividends With This ETF

In recent years, income investors eagerly flocked to high dividend stocks, including consumer staples and utilities fare, as avenues for generating income and capturing yield in a low interest rate world. However, times changes and with some fixed income traders wagering that the Federal Reserve is poised to raise interest rates multiple times this year, high-yield dividend stocks could easily fall out of favor.

S&P 500 dividend growth is slowing, and earnings for the benchmark U.S. equity index's member firms began contracting in late 2014. Combine that with geopolitical headwinds, concerns about valuations and other issues, and it's easy to see why investors are prizing stocks with dependable dividend growth track records.

The SPDR S&P Dividend (ETF) SDY, one of the largest U.S. dividend ETFs, only holds stocks with a minimum dividend increase streak of 20 years.

“The need for income in portfolios is still a top concern. So, while high dividend paying stocks could be facing potential headwinds, investors may want to keep an eye on a certain segment of dividend stocks that may be better positioned to weather the environment: Dividend growers — firms that have a long history of consistently raising their dividend to provide stable income and growth,” said State Street Global Advisors (SSgA) in a recent note.

Dividend Growers

SDY, which holds 108 stocks, tracks the S&P High Yield Dividend Aristocrats Index. That index's name clearly implies exposure to high dividend sectors, and SDY features that as the consumer staples and utilities sectors combine for nearly a quarter of the ETF's weight. However, SDY has ample cyclical exposure as industrials and financial services names combine for almost a third of the ETF's weight. Additionally, the materials and consumer discretionary sectors combine for over 19 percent.

In The Bear's Den

Another critical element with dividend growth stocks is that these stocks perform notably less poorly during bear markets. According to State Street data, the average drawdown for the S&P 500 during its worst 15 months is almost 7.6 percent but the average drawdown for SDY's underlying index during those months was less than 5.8 percent.

Investors should be careful of viewing dividend stocks as defensive, non-cyclical ideas. As highlighted by SDY's roster, it is possible to tilt cyclical while generating income.

Viewing dividend payers as defensive “is hurting investors’ view of dividend stocks, which tend to be seen as defensive in nature. But it’s important to note that not all dividend stocks are defensive, and dividend growers tend to be more cyclical — with higher weights towards consumer discretionary, industrials, financials and materials than found in high dividend yielders,” added SSgA.