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Is The Yield Trade Dead?

For a while there, anything with a dividend was rocketing skyward. Each cut from the RBA made ASX yields that little bit more attractive, giving income investors a truck-load of (not-unwelcomed) capital gains. But with many pundits eying higher interest rates on the horizon, is the so-called “yield play” coming to an end? Should investors be thinking of cycling out of dividend stocks, and back into growth?

Since our central bank started cutting rates back in late 2011, shares in income stalwarts like Sydney Airport Holdings Ltd (ASX:SYD) and toll-road operator Transurban Group (ASX:TCL) have more than doubled. To be fair, these are — in my view — some of the best income stocks on our market, and both have managed to substantially lift their cash payments to shareholders over the period. But it’s been the drop in interest rates that’s done the bulk of the heavy-lifting.

It’s a similar story for many of the Real Estate Investment Trusts (REITs). Though these can provide reliable income streams, the growth component typically doesn’t inspire — and yet, in the past five years the A-REIT index has smashed that of the wider market.

The shine really started to come off a lot of these income-plays back when Trump won the US Presidential election. His pro-growth agenda, supported by lower taxes, increased spending and domestic industry support, coupled with the ongoing recovery in the the US economy, led most experts to call a start to the next “tightening” cycle. Indeed Janet Yellen and Co. at the US Federal Reserve have indeed appeared to have taken a more “hawkish” stance, with the official US rate having been lifted twice in the past 6 months, for a total of half of one percent.

And, to be fair, interest rates probably deserved to be further increased. So-called emergency rates that were enacted in the wake of the ‘Global Recession’ are becoming less and less justified in the face of steadily improving conditions. And, of course, Central banks no doubt want a more neutral stance on monetary policy, just so they have some ‘dry-powder’ for the next time the economy needs a kick-start.

But despite all of this, I don’t think the prudent income investor should dump all their dividend stocks.

Yes, the RBA probably has a ‘tightening bias’, but the degree to which it can lift interest rates is severely restrained by the sheer level of household debt. If the RBA sees a need to tap the brakes, so to speak, even a modest increase in rates will do the trick.

In fact, I’d suggest that if the RBA were to return rates to the average level we saw in the noughties, many households would be taken to the brink. Consumer spending would nosedive and the economy would plunge into a recession.

Ok, so income stocks likely won’t deliver the kinds of massive capital gains that the previous loosening cycle underpinned — valuation metrics have already adapted to the new-normal of lower-for-longer. But the better ones will continue to spew forth a steady stream of reliable and growing dividends. Most of them will come with those fantastic franking credits, helping to boost the after-tax return.

And there’s a lot of good stuff on offer at the moment — especially once you go outside of the crowded top 50 stocks. At Motley Fool Dividend Investor, the service I run, we have a scorecard full of under-the-radar income dynamos that are offering compelling yields and a solid amount of growth potential.

The era of falling rates and easy gains may be over, but there’s still loads of opportunity for the discerning investor.

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Motley Fool contributor Andrew Page has no position in any stocks mentioned. The Motley Fool Australia owns shares of Sydney Airport Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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