Rising Yields May Stifle Boom in Dividend Stocks

NYSE traders
Getty Images

The Standard & Poor's 500 collectively no longer yields more than government bonds, calling into question whether the rush to high dividend-payers this year can continue.

One of the main selling points for the market had been that there was no better place to go for a steady income stream.

Sub-2 percent benchmark Treasury yields offered little alternative to an S&P 500 that had been yielding until recently a shade higher than bonds.

(Read More: Goldman: This US Treasury Sell-Off Is for Real)

That dynamic has changed, though, as the surging market has meant lower collective dividends, in turn posing a challenge to investor habits.

The S&P 500 dividend yield was 1.93 percent Friday, while the 10-year Treasury yield stood at 2.09 percent.

"Dividend stocks in the last few days have been taking a beating, which has been expected. We've been waiting for this," said Howard Silverblatt, senior index analyst at S&P Capital IQ. "But dividend stocks are up for the long term."

Indeed, S&P 500 companies paid a record $37.5 billion in dividends during May.

(Read More: Can Global Markets Shake Off the Nikkei Jitters?)

That kept up the pace of a record-setting year in which $124.7 billion dividends have been paid out, compared with $112.6 billion in 2012.

Yet dividend stocks have been on the receiving end of bad press lately.

The highest yielders are trading at near-record premiums to their lower-yielding counterparts, according to a warning from Savita Subramanian, equity and quant strategist at Bank of America Merrill Lynch.

She warned investors against chasing dividends in the current environment of high payouts and said a "low-beta bubble" looms.

"Investors should care more about the underlying earnings risk, as well as balance sheet quality, sustainability of dividends, and a host of other factors that play into the safety of an investment," she said in a note to clients.

"Today, an opportunity to buy high-quality stocks and sectors as exhibited by lower fundamental betas at lower valuations is still apparent, and we believe this underscores a fundamental mispricing of risk among equities," Subramanian added.

Indeed, investor appetite for dividend stocks has been huge.

The Vanguard Dividend Appreciation exchange-traded fund has pulled in $2.17 billion in 2013, the ninth-most among ETFs, according to IndexUniverse. The fund is off 0.4 percent this week but up 15 percent this year.

(Read More: This Chart Shows Dow Should Be (a Lot!) Lower)

The Vanguard High Dividend Yield fund also has been popular, pulling in $1.13 billion while gaining 17 percent in 2013.

The dividend trade at its core is about safety.

Investors who fear market volatility want to know they'll still be getting paid even if their stocks become subject to severe market gyrations, and they're willing to accept underperformance in price.

That could be a losing strategy in the days ahead.

"Stocks that pay the highest dividend generally have higher payout ratios and lower growth, and thus are less likely to grow dividends," Subramanian said. "And many stocks migrate into high dividend yield territory from falling prices, and these stocks are actually much more likely to cut their dividends than to retain or grow dividends."

_By CNBC's Jeff Cox. Follow him on Twitter at @JeffCoxCNBCcom.