Dividend Seekers Should Stick With The Dogs In 2017

For much of the past couple of years, we’ve seen income investors abandon the fixed income markets and did their toes into the equities markets in search of higher yields. The Fed’s widely expected rate hike in December made those dividend yields look slightly less attractive. If the Fed’s forecast of three more hikes in 2017 comes to fruition, we may start to see a rotation out of dividend ETFs and back into fixed income.

With an improving outlook for fixed income yields and valuations on dividend stocks starting to look a little expensive, investors will want to approach their dividend ETFs with caution. Long term investors won’t want to abandon dividend ETFs altogether, just be a little more picky about where their dividends are coming from.

The ALPS Sector Dividend Dogs ETF (SDOG ) targets the five highest yielding stocks from each of the ten GICS sectors (real estate is currently not considered) and equal weights them. The fund’s current yield of 3.3% far outweighs the S&P 500’s yield and constructs the portfolio in a way that doesn’t reach for dividend payers.

Many high dividend ETFs dig deep into the traditional income sectors like utilities and consumer goods & services to fill out their portfolios. The problem with that strategy in the current market environment is that valuations in those areas have become quite stretched. The Consumer Staples Sector ETF (XLP ) and the Consumer Discretionary Sector ETF (XLY) both trade at forward P/E ratios of over 20 compared to the S&P 500’s (SPY ) 18 multiple. The Utilities Sector ETF (XLU) trades at a multiple of 17, significantly above its historical average.

Given the equal sector weightings, the Dividend Dogs ETF has 30% allocated to these sectors. Some of the biggest dividend ETFs, such as the Vanguard Dividend Appreciation ETF (VIG) and ProShares S&P 500 Dividend Aristocrats ETF (NOBL) have more than 40% of assets in these areas. One of the biggest dividend ETFs, the iShares Select Dividend ETF (DVY) has more than 50%. Heavy investment in these areas exposes shareholders to downside risk, especially in an environment where Treasury rates are finally beginning to look more attractive.

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