The notion of higher interest rates continues to toy with investors that have spent the last five years foraging for income alternatives. For years, investors have crowded into bond funds and real estate investment trusts (REITs) for yield. However, these gravy trains are incredibly crowded trades — just as the outlook for higher interest rates is strengthening.
Click to Enlarge Last week’s jobs report increased the probabilities for a rate hike in September or October by 11% and 14%, respectively — which means the market is increasingly expecting that we’ll see a rate hike before many analysts’ targets of early 2016. This likely would cause additional selling pressure on bonds and equities alike.
However, there are pockets of strength among some modest-paying dividend stocks where investors can seek out safe harbor.
Financials and insurance companies often benefit from rising-rate environments as revenue strengthens from traditional operations. As a result, many companies within these groups can be considered suitable alternative dividend investments with the potential for less capital risk (or even gains) as fundamental valuations increase.
Regional banks tend to offer a little more upside from higher rates, as the balance sheet operations are often more rate-centric versus larger banks that also draw revenue from trading, wealth management, investment banking and other activities.
The table above lists several dividend stocks that offer modest yield, and look much more attractive thanks to the current environment. Read on, and we’ll look at the three best opportunities of the bunch:
Safe-Haven Dividend Stocks: Huntington Bancshares (HBAN)
Dividend Yield: 2.1%
Huntington Bancshares (HBAN) is firmly entrenched in a intermediate- and long-term bull market as shares and their respective long-term technicals are trending higher. Considering that HBAN has retraced less than halfway back to its 2007 highs, there’s a lot of potential upside remaining.
HBAN shares yield 2.1% on dividends, better than the 1.9% average for the regional banks. Meanwhile, Huntington is getting the cold shoulder, evidenced by the fact that only 39% of the analysts covering the stock have it ranked a “buy.”
For reference, HBAN shares returned 32% from July 2012 through September 2013 — the last time the yield on 10-year Treasuries rose significantly as a result of FOMC activity. This return beat the S&P 500’s return of 21% for the same period.
We’re expecting to see similar activity from HBAN over the next year.
Safe-Haven Dividend Stocks: Fifth Third Bancorp (FITB)
Dividend Yield: 2.5%
Another regional powerhouse is Fifth Third Bancorp (FITB). Similar to HBAN, FITB shares have yet to regain even half of their 2007 values, and they’re also in a strong long-term bullish trend.
FITB, which currently yields 2.5%, returned 38% during the July 2012-September 2013 period when rates crept higher. These returns came with less volatility than the market, making FITB an attractive hold for multiple reasons.
Finally, the sentiment profile on FITB shows low analyst ranks (55% buys), suggesting two things: Shares are not representing a “crowded trade,” and they’re more likely to see upgrades as they perform better than the market. Both of these qualities normally indicate extended upside potential for a stock.
We see the higher-rate scenario playing out well for FITB, with a target of $23 — 10% higher — before year’s end.
Safe-Haven Dividend Stocks: Regions Financial (RF)
Dividend Yield: 2.3%
Regions Financial (RF) combines a nice dividend with a high Behavioral Valuation Score (our proprietary scoring system), suggesting that shares should provide a significant alpha opportunity while maintaining a little income (2.3% at current prices).
Regions’ Behavioral Valuation profile shows significant signs of pessimistic sentiment, meaning that RF stock is likely to benefit from a “Wall of Worry” to climb higher. The pessimistic sentiment is represented by high short interest and low analyst rankings, both of which suggest the stock is susceptible to covering rallies (both short covering and analysts covering their butts by upgrading the stock as it outperforms the market).
We’re looking for RF to surge roughly 25% higher to $13 by the end of the year.
As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.