Intel Corporation (INTC), Merck & Co., Inc. (MRK): Bond Yields Are Rising — Do Your Stocks Measure Up?

The good news: A 4% yield on the 10-year U.S. Treasurys has historically coincided with healthy stockmarkets. That yield simply isn’t high enough to pull vast sums out of the stock market and into the bond market, as was the case in the 1970s.

Still, that’s not all good news for dividend-paying stocks. After all, the average yield on stocks in the S&P 500 is currently around 2%. As bond yields rise, stocks with that kind of yield will keep rotating out of favor until they offer up yields (and capital appreciation) that promises a better payback.

Let’s look at the major drugmakers as an example. As I noted last week, drug stocks traded for a number of years with dividend yields in excess of 5% to compensate for a lack of share price growth. Yet over the past year, these stocks have rallied higher, in part due to a firming broader market and investors’ search for yield plays. Merck & Co., Inc. (NYSE:MRK), for example, has rallied nearly 50% since October 2011, and its yield has fallen from above 5% to a recent 3.6%.

When rates start to rise, will investors start to flee stocks like Merck & Co., Inc. (NYSE:MRK)? If that happens, a falling share price will boost the yield, creating a fresh entry point for stocks like this.

As we’ve noted in other recent columns, it’s really dividend growth that counts. Merck & Co., Inc. (NYSE:MRK)’s dividend was frozen at $1.52 a share for six straight years before a one-time 10.5% increase last year, to $1.68. The 2013 dividend was boosted another 2%, which is likely a sign of things to come. As you seek out dividend plays, look for companies that are capable of generating robust dividend growth such as Ford Motor Company (NYSE:F), Intel Corporation (NASDAQ:INTC), JPMorgan Chase & Co. (NYSE:JPM) and others.

Risks to Consider: It’s unclear how the bond market will respond to the eventual end of the Fed’s quantitative easing programs, especially as all of the liquidity that was pumped into the economy gets reabsorbed. So a chaotic bond market response cannot be ruled out.

Action to Take –> More than likely, the remaining global economic headwinds will keep our bond market from running into trouble. Instead, look for an orderly and gradual rise in interest rates that leads investors to re-assess the appeal of various income-producing stocks. There’s no need to rush out and make radical moves now, but get ready to establish a long-term plan that accounts for changing interest rate trends.

This article was originally written by David Sterman and posted on StreetAuthority.