The Power of Dividend Stocks and Interest Rates

Investing in dividend stocks has consistently proven to be a successful strategy on Wall Street, outperforming non-dividend-paying stocks over the past 50 years. As interest rates fluctuate, certain dividend stocks become more attractive investments.

• Dividend stocks have more than doubled the average annual return of non-payers from 1973 to 2023, according to a report by Hartford Funds.
• Income stocks achieved an average annual return of 9.17%, while non-payers returned only 4.27%.
• However, not all high-yield dividend stocks are worth investing in, as some may have unsustainable yields due to failing business models.

Ultra-High-Yield Dividend Stocks and Interest Rates

Two ultra-high-yield dividend stocks, Annaly Capital Management (NLY) and AGNC Investment (AGNC), with yields of 12.5% and 13.9%, respectively, are well-positioned to thrive as interest rates ease.

• These mortgage real estate investment trusts (REITs) borrow at lower short-term rates and invest in higher-yielding long-term mortgage-backed securities (MBSs).
• Their profitability depends on maximizing the net interest margin, which is the difference between the yield on their assets and their borrowing costs.

The Impact of Rising Interest Rates on Mortgage REITs

The mortgage REIT industry has struggled in the recent past due to rising interest rates and the Federal Reserve's aggressive rate-hiking cycle.

• Rapidly increasing short-term borrowing costs led to shrinking net interest margins for mortgage REITs.
• The velocity of the Fed's policy moves made it challenging for REITs to reposition their assets to maximize returns.
• Most mortgage REITs experienced declines in book value and net interest margin since March 2022.

The Light at the End of the Tunnel: Rate-Easing Cycle

With inflation cooling and the Federal Reserve initiating a rate-easing cycle, Annaly Capital Management and AGNC Investment are well-positioned to benefit.

• Lower interest rates will reduce their short-term borrowing costs, allowing for an expansion of net interest margin.
• These REITs have been able to acquire higher-yielding MBSs during the rate-hiking period, further boosting their net interest margin.
• The Fed's well-telegraphed moves during a rate-easing cycle will enable REITs to position their portfolios optimally.

Normalization of the Yield Curve and Agency Securities

The normalization of the yield curve and the REITs' focus on agency securities are additional factors that favor Annaly and AGNC.

• A normalized yield curve, with longer-dated bonds yielding higher than short-term bonds, benefits mortgage REITs.
• Annaly and AGNC primarily invest in agency securities, which are backed by the federal government, providing additional security.
• This protection allows them to prudently leverage their portfolios to maximize profits and sustain their high dividends.

Investing in High-Yield Dividend Stocks

While ultra-high-yield dividend stocks like Annaly and AGNC come with added risks, they present attractive opportunities as interest rates ease and monetary policy becomes more favorable for mortgage REITs.

• Investors should carefully evaluate the sustainability of high dividend yields and the underlying business models.
• Diversification and a long-term investment horizon are essential when investing in high-yield dividend stocks.
• Regular monitoring of economic conditions, interest rates, and the Federal Reserve's monetary policy is crucial for managing risks and maximizing returns.

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