State Street SPDR ETF: Inflation, Fed policy and the case for dividend stocks

State Street SPDR ETF: Inflation, Fed policy and the case for dividend stocks

ETFs Inflation Monetary policy
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Stocks with a value bias, such as dividend stocks, stand to benefit in 2022. The high inflation prints we have seen in consumer prices (i.e. CPI) since Q2 2021 are leading policy makers to abandon their “transitory inflation” thesis and pursue a tightening of monetary policy in 2022.

The US Federal Reserve’s (“Fed”) plan to both raise interest rates and reduce asset purchases should continue to drive interest rates higher, further compressing the valuation premium of longer-duration (growth) stocks. While the Fed has been clear on its intention to raise interest rates, market speculation around the timing and magnitude of rate hikes is likely to cause short-term volatility.

We believe the fundamental shift in interest rate policy this year makes a strategic allocation to Dividend stocks relatively attractive for three reasons:

  1. The tightening of monetary conditions could likely lead to continued compression of the valuation premium of long-duration equities, such as growth equities.
  2. Dividend stocks are inherently shorter duration as they convert today’s earnings into immediate income for shareholders.
  3. Investors have put money to work in dividend stocks, but these stocks remain under-owned.

The last time the Fed engaged in a policy of coordinated interest rate hikes, USA and Global Dividend Aristocrats strategies outperformed the market benchmark. In the first six months of 2016, following the initial Fed rate hike in December 2015, the USA and Global1 Dividend Aristocrats indices outperformed the MSCI ACWI by 14% and 8.2%, respectively (see Figure 1).

Figure 1: Fed Funds Rate and Index Returns (Trailing 6-Month Returns)

24022022 SPDR (1)

Based on figures from the State Street SPDR Q1 Smart Beta Compass we can see investors are significantly underweight high dividend yield stocks (on a historical basis), but they are starting to buy. The 60-day and 20-day trend flows into high dividend yield stocks are positive and accelerating from a historically underweight position.

Figure 2: Institutional Style Positioning (Quarter End)

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