Q: I've noticed that high-yielding stocks, particularly REITs and utilities, have been performing very well in recent months. Is there a reason for the strong performance?
Over the past month, real estate and utilities are up by 4.3% and 2.1%, respectively, as compared to the S&P 500's 2.3% loss during that time.
Without getting into a complex economic discussion, there are two basic reasons why they've done so well.
First, real estate and utility stocks generally pay above-average dividend yields. Interest rates on Treasury securities have fallen dramatically in recent months, and this has sent investors flocking to dividend stocks in search of yield.
Furthermore, income-seeking investors expect a certain "risk premium" over what they can get from risk-free investments like Treasuries, so when risk-free yields drop, dividend yields tend to move in the same direction. Because price and yield have an inverse relationship, lower yields mean higher prices.
The second main reason real estate and utilities have outperformed is because recession fears have been building lately, and these are two defensive sectors. Think of it this way: During tough economic times, consumers take fewer vacations, shop less, and tend to spend less on the latest gadgets. On the other hand, their rent and utility bills are among the last things they cut back on.
The caveat is that these two sectors tend to underperform the market in booming times, especially if those times are accompanied by rising interest rates. However, they have the potential to outperform dramatically when times get tough. If a recession actually hits, real estate and utility stocks' recent outperformance could be just the tip of the iceberg.