The Bank of Canada’s decision to cut its key interest rate this week might invigorate economic activity and reduce borrowing costs – but it will also make the hunt for attractive dividend stocks much harder.
Thanks a lot, Bank of Canada.
You may recall the days when the picking was easy. Less than a year ago, inflation was sticky, interest rates sat at a two-decade high of 5 per cent and market sentiment rested on the idea that rates would remain higher for longer than anyone had anticipated.
Big dividends were for the taking. In October, 2023, Fortis Inc.’s (FTS-T) dividend yield was 4.7 per cent, Canadian Imperial Bank of Commerce (CM-T) had a yield of 7.5 per cent and TC Energy Corp. (TRP-T) yielded 8.2 per cent, to name just three standouts.
Sure, stubbornly high inflation cut into the returns generated by dividends and other yield-bearing investments. But the nominal returns were spectacular, and anyone with a smidge of patience could entertain a future when inflation was tamed.
That time has arrived, but it’s a bittersweet moment.
On Wednesday, the Bank of Canada lowered its rate to 4.25 per cent, marking the third cut since early June as it responds to declining inflation and slower economic activity. CIBC economists expect the rate will decline to 2.5 per cent by next year, implying eight more cuts in the months ahead.
The higher-for-longer chant is fading. So are many of the big dividend yields that appealed to investors last year.
Fortis now yields 3.9 per cent after the share price rallied about 20 per cent from its recent low in October. CIBC’s yield is now 4.5 per cent. The low-hanging fruit is gone.
More broadly, the iShares S&P/TSX Composite High Dividend Index ETF (XEI-T), an exchange-traded fund that provides exposure to 75 stocks, has gained 18 per cent since October. The move has reduced the indicated yield from 6 per cent to 5.2 per cent.
That is just half a percentage point above the yield at the end of 2019, when inflation was low and the Bank of Canada’s benchmark interest rate was parked at 1.75 per cent, suggesting that additional rate cuts may be baked in already.
The situation in the United States is similar. Even though the Federal Reserve has not yet cut its own key interest rate, most observers believe that cuts are coming and financial markets are reflecting this expectation.
The SPDR Portfolio S&P 500 High Dividend ETF (SPYD-A), a fund that provides exposure to U.S. dividend stocks, has rallied 10.4 per cent over the past three months – easily outperforming the 3-per-cent gain for the S&P 500 over the same period.
Investors who embraced dividends over the past couple of years can now gloat over their foresight. But declining yields suggest that the best days for buying dividend stocks are behind us.
Buying stocks with standout dividends now requires venturing deeper into riskier territory than banks, utilities and pipelines.
It means looking at telecoms, whose share prices are beaten-up because of intense competition for smartphone customers. Or office real estate investment trusts, where some companies are still struggling with high vacancy rates and wobbling building values. Or oil and gas producers, which are at the mercy of volatile commodity prices.
Even these sectors, though, are far from undiscovered. Allied Properties REIT, which owns workspaces in large Canadian cities, has rebounded 15 per cent since late June. BCE Inc. (BCE-T) has gained 13 per cent over a similar period.
Full disclosure: I’m up to my eyeballs in dividend stocks, including BCE, Telus Corp. (T-T), Enbridge Inc. (ENB-T), RioCan REIT (REI.UN-T) and Brookfield Infrastructure Partners LP (BIP.UN-T), along with various ETFs. And I’m nursing tremendous disappointment over missing an opportunity to add Fortis to the mix earlier this year, before the stock took off.
The case for buying dividend stocks at today’s relatively lofty prices now rests on another wave of investors joining the fray, driving up prices even more.
The case is persuasive. Investors have been stuffing their savings into high-yielding money market funds and GICs over the past couple of years in pursuit of risk-free 5-per-cent yields, which weighed on dividend stocks initially.
As interest rates fall, these cash-like investments will lose their appeal, encouraging investors to seek income elsewhere. Dividend stocks are a natural alternative, and more interest in them could drive down yields even more.
For current investors, that’s not a problem. For those who want to buy more, though, it’s a sad reminder that the best opportunities may have disappeared.