Investing
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- Interest rate cuts are widely expected to restart this month.
- They could lead to certain dividend ETFs appreciating sharply.
- The following three in particular are well-positioned to do just that.
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Investors have been anxiously waiting for September, and it’s finally here. The Federal Reserve has been hinting for months that September is when it will start to cut interest rates, and betting markets are also convinced, with over 80% agreeing on a 25bps cut. The Fed has tacitly gauged public sentiment to guide its decisions, so the cut will likely happen.
A terribly high inflation read on Thursday, September 11, is the only roadblock that could derail it. So far, analysts expect CPI to rise by 0.1% to ~2.8%, and the Fed should be able to digest such a rise and start cutting. Fed Chair Jerome Powell may balk if inflation unexpectedly soars beyond 3%. The core inflation rate is already at 3.1%, and this is a metric the Fed pays more attention to.
Regardless, the unceasing political pressure for further cuts is another element that may nudge it beyond the finish line. Here are three dividend ETFs to look into if you think rate cuts are likely:
iShares Preferred and Income Securities ETF (PFF)
The iShares Preferred and Income Securities ETF (NASDAQ:PFF) is a passively managed ETF that gives you exposure to preferred stocks and hybrid securities. If you don’t know what preferred stocks are, they have features of both stocks and bonds. Preferreds have priority over common stock and pay fixed dividends that are significantly higher.
PFF hasn’t performed that well, down 13.7% over the past five years. This is due to a large number of investors pouring money into Treasuries. Treasury yields are above 4% on average, with the 30-year at 4.963% as of this writing. If you’re getting this much yield without risk, why bother with PFF?
But will the yields stick around forever? Nope. Once interest rate cuts start, Treasury yields will follow suit and start going down. This will leave investors no choice but to rotate back into preferred shares, increasing their value. In turn, PFF will appreciate.
PFF currently yields 6.2% and dividends are paid monthly. The net expense ratio is 0.45%, or $45 per $10,000.
iShares 20+ Year Treasury Bond ETF (TLT)
Speaking of bonds, iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) is a great bet. While interest rate cuts will inevitably bring down bond yields, there’s more to it than meets the eye. If you buy into long-term bonds, you can lock in an extremely attractive yield. The economy might not see ultra-low interest rates like after 2008, but we could certainly see 1-2% a decade out.
If you are holding a risk-free asset that yields nearly 5% in that environment, investors will be willing to pay a lot more for it.
Post-2008, when rates plummeted near zero, long-term Treasuries rallied sharply. The opposite is the case when rates increase. From August 2020 to today, TLT has declined by around 50%, but has been trading sideways recently. Rate cuts could reverse this trend and lead to significant gains.
TLT yields 4.6% and also pays monthly. The expense ratio is just 0.15%, or $15 per $10,000.
Vanguard Real Estate Index Fund (VNQ)
The Vanguard Real Estate Index Fund (NYSEARCA:VNQ) is an ETF that tracks the MSCI U.S. Investable Market Real Estate 25/50 Index. This includes publicly traded equity real estate investment trusts (REITs) and other real estate-related companies.
Low interest rates are great for the real estate sector. Lower rates reduce borrowing costs for REITs, meaning they can refinance debt more cheaply, fund new developments, and improve profit margins. In turn, this will drive up property valuations and cash flows. I expect VNQ to outperform the broader market during this easing cycle.
Unlike PFF and TLT, VNQ has not been battered much from pre-pandemic prices and has actually been on an uptrend year-to-date. REITs have weathered high interest rates remarkably well. Companies in this sector have learned from 2008, so I don’t see a similar crash happening anytime soon, especially with real estate demand remaining strong.
VNQ gets you a 3.76% dividend yield with a net expense ratio of 0.13%, or $13 per $10,000.
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