With Fed cuts expected later this week, dividend stocks have outperformed over the last several weeks. Should we expect them to turn the tide or continue their long-term outperformance?
The leadership of growth-focused areas has shined brightly this year, and in their shadow, dividend stocks have struggled to keep pace. However, there are some initial signs of renewed optimism for higher dividend names as potential rate cuts from the Fed approach. The market now expects a 100% chance of at least a 0.25% cut at this week’s FOMC meeting (Source: CME FedWatch), which has helped push the prices of certain dividend stocks higher over the past couple of months.
Dividend stocks benefit from falling interest rates, as their yields become relatively more attractive to fixed income as rates drop. The market’s hope for rate cuts were dampened earlier in 2025, as the Fed hasn’t cut since last year. High dividend stocks usually have a defensive tilt, representing mature companies in established industries with lower growth prospects. The combination of fewer rate cuts than anticipated and a market dominated by growth and risk-on areas has served as headwinds for dividend stocks. However, given some shifting in the tides ahead of potential rate cuts, how should investors navigate dividend stocks in their portfolio?
To analyze more closely, we split the S&P 500 (SPX) into five baskets (quintiles) based on dividend yield entering 2025. So far this year, the highest yield group has gained 2.8% on average, significantly lagging the market. That said, the group has shown signs of life in recent months, rising 4.1% since the end of June to gain the most any group. The lowest dividend stocks have fallen behind over that span, declining 0.1% to now have a YTD return below that of even high yield stocks. Meanwhile, the dividend “middle class” has fared the best this year, with the three middle groups outperforming the average stock by several percentage points. So while dividend stocks have improved recently, most areas have still done better this year.
Relative strength seconds this notion, especially when looking at the strength of dividends funds versus S&P 500 funds. The SPDR S&P 500 ETF Trust (SPY) holds a strong fund score of 5.18 while the Invesco High Yield Equity Dividend Achievers ETF (PEY) is at 1.59, resulting in a 3.59-point difference between the two. Looking at the graph of the difference in scores, the gap recently reached its largest level on record. That said, things have calmed down from their heights, with that difference falling a full point from 4.6 the start of August. The change is due mostly to PEY rising 0.91 points from an abysmal 0.68 fund score. However, with PEY remaining firmly below a 3.0 fund score, dividend stocks have yet to break out into acceptable territory, especially relative to the broader market.
Long-term NDW readers know that relative strength matchups are one of the best ways to gauge long-term strength, and the RS chart between PEY and SPY confirms that relative strength prefers broader market. The total return RS chart on a 2% scale has historically been an additive relationship, and PEY is currently on a streak of RS sell signals dating back to early 2023. Meanwhile, it lost near-term strength in April when SPY rebounded off its Liberation Day lows.
Interestingly, conditions are at historically extreme levels against dividend stocks in both the fund score differential and the RS chart, with us currently at levels not seen since before the tech selloff in the early 2000s. However, just because things are near highs doesn’t mean that things are bound to reverse in the near-term. Dividends stocks earned significantly more strength than the market starting in 2000, but it wasn’t until around 2007 that it fell out of favor. Momentum’s power doesn’t lie in predicting which trends will persist indefinitely, but in identifying when trends have shifted. After all, every trend will reverse eventually, and movement in favor of income stocks is bound to be repeated at some point. However, history has shown that these trends can persist for some time.
Rate cuts and a slowdown in growth stocks could certainly act as catalysts for dividend stocks to reclaim relative strength, and recent movement does offer potential for this to transpire. However, long-term strength continues to reside heavily in the core of the market. Until we see clear signs of change, it remains hard to place focus on dividend stocks outside of select names.
