Inflation and rising interest rates have moved the goalposts for that great Canadian pastime – dividend investing.
For many years, stocks paying a decent dividend have drawn strength from declining rates and yields.
Now with consumer prices rising at their fastest pace in decades, and with the Bank of Canada shifting to inflation-fighting mode, yield strategies are facing a test.
The playbook for these kinds of moments suggests lightening up on the sectors most vulnerable to rising rates, such as utilities.
This time around, some market movements have deviated from long-established patterns. The technology sector has taken a beating, for example, while many utilities have held up quite nicely.
“It’s such a different reaction than you would traditionally expect,” said Ryan Bushell, president and portfolio manager of Toronto-based Newhaven Asset Management. “The normal fundamentals that used to rule the day have been distorted by flow of funds.”
With so much money flowing out of Big Tech over the past couple of months, investors have redistributed hundreds of billions across other sectors, in many cases dwarfing the negative effects of rising rates.
Consider Shopify Inc. Since topping out in November, the company has lost roughly $130-billion of market capitalization, which is about 80 per cent of the size of the entire utilities sector in the S&P/TSX Composite Index.
Over that same period, Fortis Inc. and Hydro One Ltd. each gained 5 per cent to 6 per cent, despite the increase in Canadian long-term bond yields, which would typically be a negative for the share prices of such utilities.
The lines have been blurred, Mr. Bushell said, with technology suddenly becoming the market’s most rate-sensitive sector.
But history can still guide a dividend strategy in today’s inflation-gripped stock market. Investors with yield-focused portfolios need to understand that not all dividend stocks are created equal.
The steady decline of interest rates and bond yields, which has been one of the most durable economic trends of the past 40 years, has been a powerful lure drawing investors into stocks that behave more like bonds.
These bond proxies, with generous dividends and more predictable returns, can be among the biggest casualties when bond yields swing to the upside. Think utilities, real estate investment trusts and telecoms.
But other segments of the dividend universe are less attuned to the bond market, or may even benefit from rising rates.
These dividend payers are more correlated with the broader economy than they are with bond yields, Craig Basinger, chief market strategist at Purpose Investments, wrote in a recent report.
“If you believe, as we do, that bond yields have embarked on an upward trajectory due to solid economic growth and inflationary pressures, tilting more toward cyclical yield would be prudent,” Mr. Basinger wrote. Prime candidates include banks and insurance companies, integrated oil companies and E&Ps, and the capital goods segment.
For most of the 2010s, when income investing was powered by falling bond yields, rate-sensitive stocks were the superior performers.
That has not been the case over the past year, as cyclical dividend-payers have outperformed while yields have drifted higher. Mr. Basinger named Manulife Financial Corp. and Nutrien Ltd. as top picks from among Canadian cyclical yield stocks.
The caveat is that this particular bucket of stocks generally needs a decent growth backdrop to perform well, Mr. Basinger said in an interview.
“This is a great framework, unless there’s a recession on the horizon, in which case cyclical yield is not where you want to be.”
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