Many stocks are struggling as bond yields rise. Meet Canada’s most rate-sensitive stock

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Stocks are again languishing in the wake of stubbornly high inflation and tough talk from central banks on interest rates. But some stocks are more affected than others.

So what is Canada’s most interest-rate-sensitive stock?

There are a lot of candidates. Technology companies with lofty growth ambitions have seen their valuations shrink as rates rise. Banks are faltering with sluggish loan growth and concerns about the ability of consumers and businesses to repay loans as borrowing costs rise.

Slow-growing utilities look far less appealing when income-generating bonds offer meaningful competition. And retailers are fumbling through concerns about a looming recession.

Here’s one approach that cuts through the clutter: Rank the 11 sectors within the S&P/TSX Composite Index based on three-month returns, then isolate the worst-performing stock within the worst-performing sector.

Looking at large groups of stocks removes outliers whose performance might not have much to do with the sweeping factors buffeting the market. And a three-month return focuses on a period when the yield on the 10-year U.S. Treasury bond awoke from its mid-year slumber.

The bond’s yield has risen from 3.725 per cent on June 21 to a new multi-year high above 4.5 per cent on Thursday, a day after the U.S. Federal Reserve held its key interest rate steady but hinted that rates could remain higher for longer.

As bond yields have risen, communication services – or telecom stocks – have been the worst performers over the past three months, falling 8.5 per cent (as of Thursday’s close).

Within the sector, Telus Corp. T-T, which has fallen 11.1 per cent, or slightly worse than BCE Inc.’s BCE-T 9.7-per-cent decline, is the biggest laggard (full disclosure: I own shares). The stock is near levels last seen during the pandemic lockdowns in 2020.

This poor performance might not be surprising. Canada’s telecom sector is mature and highly regulated, with just a few significant players. This makes it unlikely that any one company will benefit from spectacular growth or win significant market share from its competitors.

Instead, investors turn to telecom stocks for their big dividends and stability; we all need phones and internet access. But as bond yields rise, dividend yields often rise as well.

“This is as a direct result of investors beginning to switch out of high-yielding equities and into bonds for their perceived more favorable risk-adjusted return,” Robert Gill, portfolio manager at Goodreid Investment Counsel, said in an e-mail.

In other words, some investors might prefer a safe government bond over a riskier dividend stock, especially when bonds are offering similar cash payouts. As a result, share prices decline, driving up dividend yields to levels well above bonds.

In the case of Telus, its dividend yield rose as high as 6.5 per cent this week, up from 4.8 per cent a year ago, when the share price was considerably higher and bond yields lower.

Okay, there are other factors at work here in Telus’s share price, and telecoms in general.

Mr. Gill pointed out that Telus has enjoyed a loftier valuation than its telecom peers, making the stock more vulnerable to a correction. The company also reported disappointing quarterly financial results in August, amid economic headwinds and stiff competition for wireless customers.

More broadly, North American telecom companies have been struggling with investor pessimism related to weak customer growth and a recent Wall Street Journal investigation over toxic lead-sheathed cables in the United States.

Michael Hodel, director of research for communications services at Morningstar, said that the shares of Verizon Communications Inc. VZ-N typically yielded about two percentage points more than the 10-year U.S. Treasury bond over most of the past decade, including early last year.

“Since then, the yield spread to the Treasury bond has widened steadily as Verizon has struggled to grow its postpaid wireless customer base,” Mr. Hodel said in an e-mail.

The lead issue, he added, caused Verizon’s yield spread over the 10-year bond to hit 4.5 percentage points in July as the telecom’s share price fell. On Friday, the stock’s dividend yield was nearly eight per cent.

If bond yields remain high, telecom stocks – including Telus – will likely continue to struggle. But as long-term bets, the current beaten-up share prices and lofty dividend yields are hard to ignore.

“As these telecom shares come under pressure, they often offer an opportunistic chance to purchase shares of a high-quality business when it is temporarily under-appreciated and mispriced,” Mr. Gill said, adding that his company sees plenty of attractive opportunities within the telecom sector.

Telus has been particularly sensitive to rising bond yields. The bullish bet: Perhaps the stock will be sensitive to falling bond yields as well.