Dividend Stock Could Face Pressure As Appetite For Lower-Yield Bonds Diminishes

ForexNewsNow | Published on November 15, 2016 at 6:58 am

Stocks have been rallying up, defying predictions that a Donald Trump presidency would be toxic for investors. Though there have been corrections, the Dow Jones this week jumped to a record high in a demonstration of continued investor appetite for stocks.

From forex to bonds to stocks, global markets plunged as investors shifted to gold and other safe-haven investments when early U.S. election results showed Trump was leading the race to the White House. After the panic market reaction, investors started buying stocks again, pushing many stocks and indexes to new highs.

But the bonds market seems to be getting hammered by the Trump presidency. Yields on 10-year U.S. Treasury bonds shot up significantly and remain lofty, a sign that investors are dumping bonds for other investment options, especially stocks and forex. Bond prices and yields have an inverse relationship.

The selloff in the bonds market and the skyrocketing yields could complicate the picture for companies that rely on debts to fund dividends. When yields are high, these companies not only face the problem of tepid appetite for their notes, but the cost of borrowing also increases.

Telecom, real-estate and utility companies have distinguished themselves as traditional dividend payers. These companies augment their free cash flow with debt to sustain the sometimes generous dividends they pay shareholders. But high costs of borrowing could lead these dividend payers to rethink their dividend practice, perhaps resulting in dividend cuts.

Trump’s promises

If investors keep giving lower-yield bonds a wide berth, dividend companies could face even a more uncertain future in light of the policy proposals of the President-elect Trump.

As part of his promise to “make America great again”, Trump suggested he would relax regulations, increase government spending on infrastructure and cut taxes. Experts have said that if these proposals are implemented successfully, they would set the stage for inflation. First, inflation erodes the value of dividends paid on bonds. Second, inflation would cause the Federal Reserve to raise lending rates in quick successions.

But higher interest rates would further tighten the borrowing environment for dividend companies, thus putting dividends at risk. High costs of borrowing could also weigh in on trades in unconventional assets such as cryptocurrencies, which are quickly gaining popularity as alternative safe haven assets.

Improved consumer purchasing power

However, Trump’s proposal to cut corporate taxes, including a one-off tax holiday for American multinationals to bring home their cash stashed abroad, could work in favor of the stock market. If the cash is repatriated, the companies could use it to hire more staff, boost employee, buy capital equipment and invest in projects such as research and development (R&D). In that case, the repatriated cash could improve consumer purchase power, leading to more sales and earnings for companies, thus lifting stock prices.

Apple (AAPL), Microsoft (MSFT) General Electric (GE) and Alphabet (GOOGL) have collectively stashed more than a trillion dollar in overseas accounts. They have avoided bringing the money back home because of the nearly 40% tax penalty the repatriated cash would attract. But Trump wants to allow them to bring the cash back at only 10% tax rate, which should encourage the companies to wire back home their billions in offshore accounts. Apple is among the companies that have been borrowing to fund projects and repurchase stock despite having billions kept in overseas accounts.

Perhaps more cash in the U.S. could also help reignite excitement in IPO market, which has been slow this.

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