Shifting from Dividend Stocks to Treasuries: Higher Yield, Lower RiskGeneral Discussion 5 replies 0 likes 0 votes 128 views
The current market conditions are signaling a shift in investment strategies, particularly for income-seeking investors. The 10-year treasury yield has climbed above 4%, surpassing the expected dividend benchmark of approximately 3.6% from the Schwab U.S. Dividend Equity ETF (SCHD). This raises an important question: Why should investors take on the equity and volatility risk of stocks when the U.S. government is offering a higher-yielding, "risk-free" alternative? In other words, is it wise to abandon dividend stocks in favor of treasuries?
The answer, in this case, is yes. The rationale behind this decision lies within the question itself. If a risk-free bond security provides a higher income and lower risk compared to an income-focused equity portfolio, it would be imprudent not to reallocate assets accordingly.
It is true that stocks, including dividend stocks, may theoretically justify a growth premium over treasuries. However, with interest rates currently hovering around 5%, it is highly unlikely that cyclical businesses, which form a significant part of SCHD's investment strategy, deserve such an implied growth premium.
Considering the prevailing market environment, it is advisable to sell dividend portfolios or ETFs like SCHD and instead invest in treasuries such as SCHO.
The SCHD ETF focuses on dividend-paying U.S. equities, aiming to provide investors with exposure to this sector. It closely tracks the performance of the Dow Jones Dividend 100 Index (DJUSDIV), and over the past year, it has distributed approximately 3.6% of its net asset value as dividends.
SCHD maintains a portfolio of 102 securities, with a portfolio turnover ratio of around 31% over the past twelve months. The fund's investment strategy leans towards mature businesses that distribute a major share of their earnings to investors. Consequently, SCHD's equity portfolio is heavily skewed towards large-cap stocks and value opportunities, as indicated by low accounting multiples like P/E and P/B ratios.
However, SCHD falls short in terms of yield when compared to U.S. treasuries across different segments of the yield curve. The current yield on the 2-year and 10-year treasuries is around 4.96% and 4.95%, respectively, while SCHD offers an income yield of only around 3.6%. This discrepancy is unexpected, as treasuries, being "risk-free" fixed income securities, should typically trade at a discount to stocks, compensating investors for the equity and volatility risks they assume.
Another factor that favors treasuries over dividend stocks is the price risk. If the Federal Reserve (FED) reduces interest rates, which is becoming increasingly likely, the value of treasuries will appreciate. On the other hand, cyclical stocks, like those present in SCHD, may face lower earnings and equity prices in a potential recession, making them less favorable investments.
While it can be argued that stocks, including slow-growing dividend stocks, may deserve a valuation premium due to the potential for growth, it is important to note that SCHD's holdings are heavily influenced by cyclical businesses. These stocks lack exposure to structural growth trends such as AI and automation. Considering the significant increase in the fed funds rate, amounting to more than 500 basis points, it is doubtful that cyclical growth remains robust.
SCHD's largest sector weight is in Industrials (17.8%), followed by another cyclical sector, Financials (14.1%). In contrast, Information Technology only represents 12.5% of the portfolio, while the S&P 500 (SPY) has an allocation of almost 30% to this sector.
A closer look at SCHD's top 10 holdings confirms its inclination towards slow-growing, cyclical businesses.
Given the current economic landscape and the FED's efforts to cool the economy, it is highly questionable whether cyclical businesses, which form the core of SCHD's investment strategy, truly deserve an implicit growth premium. While stocks may warrant such a premium during times of economic expansion, approaching a recession can erode or even reverse this premium. Treasuries, with their "growth-free" nature, may not be a disadvantage considering the prevailing macroeconomic conditions.
To conclude, the 10-year treasury yield now stands above 4%, surpassing the expected dividend benchmark of approximately 3.6% for Schwab U.S. Dividend Equity ETF. Therefore, it is advisable for investors to consider shifting their assets from dividend stocks to treasuries, as the latter offer higher yields and lower risks.
While stocks may deserve a growth premium during economic expansions, it is argued that this premium should diminish or turn negative as a recession approaches. This argument is particularly applicable to cyclical businesses, which constitute a significant portion of SCHD's investment strategy.
In light of the FED's efforts to cool the economy, treasuries present a more favorable option for investors compared to dividend portfolios or ETFs like SCHD.