In some ways, 2015 was a tough year for income stock investors. Stock price volatility and a smattering of dividend rate reductions made investors reconsider their investment strategies and holdings. In 2016, It looks like the tide will turn and a high-yield, dividend-focused investment strategy could put investors ahead of most over stock market strategies.

In 2015, the energy and commodities sector suffered through a steep decline as crude oil and natural gas prices suffered heavy declines. The result was falling share prices for almost every energy related stock, including those companies that provide infrastructure services that are not tied to the prices of oil or gas. The exploration and production companies, those that actually drill, pump and sell energy products, have really hit hard times.

[ad#Google Adsense 336×280-IA]Dividends from E&P companies have been slashed, often to zero, from high rates when oil was trading at $100 per barrel.

Infrastructure energy companies have maintained dividend rates with many sticking to or slightly reducing dividend growth plans.

The market has ignored the fact that these are still quality income payers.

As a result share prices are down a lot and yields are at very high historical levels.

The expectations and fears of rising interest rates is another factor that led to a rough ride for income-focused stock market investors in 2015.

The equity (property owners) real estate investment trust (REIT) share values peaked in late January and slowly eroded for the rest of the year. The even more interest rate sensitive finance REITs had a sector value peak in November 2014 with a steeper decline in share values over the last year.

There are many reasons why stock market investors think higher interest rates are a negative for higher-yield stocks. Most of those reasons are not valid, but the fears will produce selling pressure and temporary declines in the share prices of companies operating in these economic sectors.

The overall stock market was also volatile in 2015, with record highs early in the year, an overdue correction in the fall and a close of the year with the stock market averages pretty much where they started out the year. As I write this on the day after Christmas, the S&P 500 has produced a 0.10% year-to-date price return and 2.2% total return with dividends included.

Since the U.S. economy is in a slow-growth 2% a year mode and the global economy is slowing, I am expecting similar, low single digit annual average returns from the stock market until something changes with the economy. That change could be another recession, which I think unlikely, or a resumption of higher growth, also unlikely unless there are significant changes in government regulatory and tax policy.

This leaves us with a high possibility that we are in for a several year or longer period of low average total returns from the stock market, interrupted by periods of painful volatility. This is a type of market where dividend-focused investors can generate attractive cash flows from higher yielding stocks and above average market total returns from higher yields and just a small amount of share price appreciation.

2016 should also bring better news for income investments in the energy sector. The market is starting to realize that infrastructure companies providing transportation, storage, and processing services will still be needed. While energy prices are down, the economy will still consume energy for transportation, heating, electricity, and manufacturing. Lower energy prices should lead to increased demand, which means that the energy infrastructure companies offering the right services will see increased demand for the use of their assets.

Also, the 40-year ban on the export of U.S. produced crude oil has been lifted. Orders are already in the works for the first shipments of crude oil exports out of the country. The infrastructure companies that own and operate the pipelines, port storage, and loading facilities needed to get the crude oil onto ships will benefit from the lifted ban. The energy sector bear market may have bottomed here in the last couple of months of 2015. For certain is that income energy stocks will be doing much better by the end of 2016. It’s just the timing of the recovery as we move through the year that is in question.

The one income danger area for 2016 is the group of companies that generate returns from the differences between short and long-term interest rates. The primary players of this game are the residential mortgage REITs. These companies own large portfolios of mortgage-backed securities (MBS) that are purchased and financed with borrowed money in the short term markets.

Profits and the high dividend yields are based on the spread between short-term interest rates and mortgage market-based MBS yields. A flattening of the yield curve will destroy the profit margins of these companies. The Fed seems determined to ratchet up short-term rates in steps, looking for a 3% yield a couple of years out. Longer-term bond rates, including MBS yields, are set by the markets and based on economic growth and inflation expectations.

I have already discussed that the economy seems to be locked into a low 2% growth rate trajectory, which means that it is more probable than not that longer term rates will not move up as fast as the Fed rate step up and may even not increase. The result is a flat yield curve with the same interest rates from short term to long term. Here are some popular high-yield stock investments that will be hurt by a flatter yield curve:

  • iShares Mortgage Real Estate Capped ETF (NYSE: REM)
  • Annaly Capital Management, Inc.(NYSE: NLY)
  • American Capital Agency Corp.(NASDAQ: AGNC)
  • Two Harbors Investment Corp (NYSE: TWO)

You can expect dividend cuts or even dividend payment suspensions from these and similar companies as short-term interest rates increase. Sell any holdings now and reinvests in stocks where dividends are secure and should grow over time.

Finding companies that regularly increase their dividends is the strategy that I use myself to produce superior results, no matter if the market moves up or down in the shorter term. The combination of a high yield and consistent dividend growth in stocks is what has given me the most consistent gains out of any strategy that I have tried.

— Tim Plaehn

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Source: Investors Alley