Key insights
- The article suggests that if the US economy slows in 2026, dividend ETFs may outperform due to rising inflation and interest rates potentially capping stock returns. Citing the 2022 bear market, it highlights that income-focused and less tech-heavy dividend ETFs provided downside protection and faster recovery. This implies a potential shift from growth to value/income strategies if economic conditions deteriorate, impacting broad equity market sentiment.
Even though U.S. stocks continue to set new all-time highs, investors still need to reckon with some warning signs. Inflation and interest rates, in particular, are pain points. The Consumer Price Index (CPI) is approaching 4% and climbing due to the conflict in Iran and soaring energy prices. It's creating an environment where the Fed may not be able to cut the benchmark federal funds rate as expected and high interest rates will be here for longer.
In many ways, it resembles the 2022 bear market. Back then, of course, inflation would rise to 9%, and the Fed needed to raise rates aggressively to try to bring it back down. 2026's environment isn't quite that extreme, but it could cap returns on fixed income and affect stock prices negatively in the near future.
So even though the S&P 500 (^GSPC +0.22%) is still hitting records, investors should at least be thinking of ways to protect themselves.
If we're using 2022 for guidance, dividend exchange-traded funds (ETFs) might be a good place to start looking.
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During that year, income products were in a bit of a boom period. Defensive equities held up well, and any ETF that avoided too much tech exposure had a much better chance of outperforming the S&P 500. Many of them did and beat the index by a wide margin.
But not only did they provide a significant degree of cushion on the downside, they recovered faster when stocks started moving higher again. Cyclical stocks, which are often a mainstay of dividend ETFs, tend to respond faster in economic recovery periods. If you think that stocks could be peaking sometime soon, dividend ETFs are a natural spot to look to protect your portfolio.
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Let's examine three high-yielding ETFs that held up much better in 2022 and turned the corner faster when the market began to recover.
The Schwab U.S. Dividend Equity ETF (SCHD 0.40%) is where a lot of people start in this category. Its portfolio of high-quality companies with above-average yields that have been paying dividends for years is a great place to look when conditions start heading south.
The S&P 500 was down about 24% from its high at one point, but this ETF managed to cap losses at around 15%. Plus, in the beginning of the fourth quarter when stocks started to turn higher, the fund continued outperforming the index right up until the close of the year.
The Vanguard High Dividend Yield ETF (VYM +0.55%) doesn't focus on balance sheet health in the way the Schwab U.S. Dividend Equity ETF does. But its diversified yield-focused selection strategy tends to position the portfolio in a more defensive way that still provides some protection.
Even though it pulled back modestly to finish off the year, the Vanguard High Dividend Yield ETF was virtually unchanged for 2022 as a whole. It exhibited virtually the same behavior as the Schwab ETF, falling around 15% at its low point and outperforming during the final months of the year. Even without the explicit quality focus, this fund managed to beat the S&P 500 by about 18% for the year.
The iShares Core High Dividend ETF (HDV 0.98%) strikes a nice balance between portfolio quality and an above-average yield. The quality component of the fund's selection strategy, which uses a pair of Morningstar measures, often holds up well at times when stock prices are declining.
The iShares Core High Dividend ETF didn't just beat the S&P 500 in 2022. It crushed it. Even with the index in bear market territory for much of the second half of the year, this fund managed a 7% gain for the full year.
Based on their composition alone, dividend ETFs can realistically be expected to outperform the S&P 500 when conditions start deteriorating. In 2022, when both inflation and interest rates were rising rapidly, dividend stocks really stepped up to provide portfolio protection.
2026 is a more tepid version of 2022 so far. But dividend ETFs are likely the direction to go again if stocks begin correcting.