One of the prominent themes that emerged in the third quarter, and one that’s highly relevant to already-jittery income investors, is the idea that the Federal Reserve is increasingly likely to accelerate its rate hike timeline to 2022.
On a historical basis, higher interest rates pinch some beloved income-generating assets, including high dividend stocks, real estate investment trusts (REITs), and others. Beyond that, the near-term macro outlook is giving some investors pause.
“This environment has not just impacted bond markets, but created unease in equities as well. With high valuations, slowing growth, and concerns around earnings amid supply chain disruptions, rising yields are just another reason stock investors are nervous,” says Global X analyst Rohan Reddy. “Income-focused investors may face the most challenges in this rising rate environment and must be prepared for the implications of hawkish policies and higher bond yields on their portfolios.”
Income investors have some other issues to consider. First, the Federal Reserve isn’t the only central bank eyeing rate hikes. That means that as higher rates come to pass around the world, global bond strategies could be pinched. Second, inflation is proving more persistent than transitory.
However, investors have outlets for surviving and thriving as rates rise and inflation lingers, including short-duration fixed income strategies and real assets (real estate, commodities, and more).
“For income investors, real assets look much more attractive in this environment because of real inflationary pressure getting pushed into the system,” adds Reddy. “Energy and real estate are two areas investors may want to consider because business models in these sectors are often able to pass through inflation.”
For its part, energy is roaring back, notching one of the more impressive worst-to-first acts in recent memory. It’s the best-performing group in the S&P 500 this year after being punished by the start of the ongoing coronavirus pandemic in 2020.
Some market observers believe energy stocks, many of which offer above-average dividend yields, can continue their torrid paces in 2022 because the sector, despite impressive percentage gains, is trailing the gains of spot oil prices. Additionally, some market observers believe that oil prices will continue trending higher next year, supported by strong demand.
“OPEC’s recent policy hold at their October meeting drove energy prices even higher after they elected to leave their production hikes stable,” notes Reddy. “US producers may need to fill the void, putting midstream energy companies that move oil and gas around the country in a prime position to capitalize. For income investors, this is a welcome development given midstream’s attractive dividend yields of 6.1%.”
Fortunately, many midstream operators are improving their balance sheets to support current dividends and repurchase shares, adding to the allure of energy as a buffer against rising interest rates and inflationary pressures.
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