High dividend yields hold appeal in a sluggish economic environment. But, investors should be wary of overpaying dividend streams in overvalued groups.
T he Fed stretched out its zero-rate expectations even further last week, reaffirming that low interest rates will remain a key feature of the investment environment. This would seem to continue to favor high-income-generating assets, but our U.S. Equity Strategy recommends that investors should be selective when looking for total return plays. Valuations of traditionally high-yielding equities are well beyond levels justified by underlying earnings. For example, equity fixed income proxies like utilities, telecoms and REITs are overvalued according to our industry valuation models. On the other hand, pharmaceuticals, integrated oils and hypermarket equities offer a high yield at prices that are not demanding versus their own relative valuation histories. Also, these equity groups (unlike the traditional high yielding ones) offer protection should long-term Treasury yields rise on the back of positive economic surprises.
Bottom line: Traditional high yielding equity sectors have very demanding valuations, and investors seeking total return should consider other less popular yield plays, including pharmaceuticals, hypermarkets and integrated oil & gas.