The Federal Reserve is set to release its latest policy statement Wednesday, and it's sure to leave investors hunting eagerly for clues about when the central bank will raise short-term interest rates. And if the central bank strikes a surprisingly hawkish tone, high-dividend stocks with expensive valuations could be the hardest hit.
The Fed has kept its target on the key federal funds rate at rock-bottom levels since December 2008 and is widely expected to finally raise rates in the third quarter of this year.
The odds of the Fed shocking the world with a June hike appear minimal. However, alongside its statement, the central bank will release its forecasts, and Fed Chair Janet Yellen will address questions in a press conference—all of which should help investors determine not only when the rate hikes will begin, but also how quickly rates will rise after that first hike.
If the Fed does sound more willing to raise rates than investors expect, all sorts of bond yields are liable to rise in sympathy with the short-term federal funds rate. And that should diminish the prospects for stocks that investors hold primarily for their fat yields.
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To determine which stocks are most vulnerable to the jump in yields that would logically follow a surprisingly hawkish Fed move, it is instructive to examine the stocks with the highest dividend yields that are trading at forward expected valuations above that of the S&P 500 as a whole.
Screening for such stocks within the S&P reveals names like communications company Frontier Communications, natural gas play OneOK and real estate investment trust HCP.
Frontier looks particularly vulnerable, says Erin Gibbs, equity chief investment officer at S&P Capital IQ.
"Frontier is one of the highest-paying dividend stocks in the S&P 500 index, and trades at an exceptionally high valuation," she wrote to CNBC. "Its notable dividend yield makes it a proxy for bonds and has pushed up its valuation—which makes it doubly vulnerable."
Of course, if the Fed appears intent on keeping rates low, the converse could prove true—and stocks levered to rates may be primed to rise.
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