After months of pressure from rising bond yields, income-generating stocks are looking more attractive, say investing leaders
Euphemistically speaking, 2023 was an interesting year for dividend stocks as rising yields across asset classes took the shine off income-emitting equities. But with central bank rate cuts in the offing, could dividend-paying companies regain at least some of their appeal?
According to Craig Basinger, chief market strategist at Purpose Investments, the rise in bond yields during the last five months of 2023 put pressure on dividend stocks across a raft of sectors. With bond yields coming back down, he says dividend stocks have recovered partially, but they’re still not back to where they were six months ago.
“There’s no question dividend stocks enjoyed preferential flows for around 15 years. Cash wasn’t paying, and bonds were paying less and less and less,” Basinger says. “Investors’ appetite for dividends has probably slowed down a little bit, because people are finding yield everywhere else.”
A ‘cozy oligopoly’
In a newly published note, Stephen Duench, VP and portfolio manager at AGF Investments, also highlighted the relative weakness in dividend stocks last year. The S&P 500 Dividend Aristocrats Index gained more than 8% – but it also trailed the S&P 500 by 18 percentage points.
“[W]hile the S&P/TSX Composite Dividend Index in Canada fared better than its U.S. counterpart, its return of nearly 10% last year was still almost two percentage points lower than the S&P/TSX Composite Index’s gain over the same 12-month period,” Duench said.
Following those challenges in 2023, the prospects for dividend stocks seem to be looking better for managers and investors – as long as they can pick their spots.
“For Canadian dividend stocks, I think the opportunities are better than they have been at any point in recent history,” says Noah Solomon, chief investment officer at Outcome Metric Asset Management. “I can’t remember the last time you had some very stable, low-volatility blue chip companies offering the kind of mouthwatering yields that they are offering today."
As a case in point, Solomon highlights Bell Communications and TELUS – both stable Canadian businesses that reside in a “cozy oligopoly” of telecom stocks, which bodes well for their ability to generate profits.
“They’re offering yields of between 6.5% and 7.5%, which are tax-preferred because they’re Canadian companies,” Solomon says. “That’s like a bond equivalent yield approaching 10%.”
In the utilities space, he sees similar opportunity from Hydro One, Emera, and Fortis, which he says are yielding about 4.5% – close to 6% bond equivalent yield when accounting for the difference in tax treatment.
A comeback for Canadian dividends?
Like Solomon, Basinger is eyeing opportunities in different industries, including telcos, utilities, and pipelines that fetch dividend yields from 5% to 8%. There are a number of bright lights shining in those segments, he says, with some dividend payers currently sitting firmly within the value band of the investing spectrum.
“We’re certainly less enthusiastic about dividend-paying companies that have more economic sensitivity,” he says. “We’re not all that excited about banks or real estate.”
Looking ahead, Duench sees the potential for “a turnaround year of sorts” in 2024 – as it stands, the trailing dividend yield of the S&P/TSX Composite Index is now slightly higher than the yield on a Canadian 10-year government bond – particularly if expectations of central banks starting to cut rates are met.
“After all, the reason why dividend-paying equities underperformed last year was largely related to the increase in interest rates over the past few years that resulted in government bond yields that were higher than dividend yields on average and much more attractive than they’ve been in a very long time, relatively speaking,” he said.
Apart from higher relative yields on income-generating stocks, Duench said the dwindling ownership of those stocks compared to the broader market could set the stage for a re-ignition of interest in dividend stocks.
“That’s not to say dividend stocks are automatically set to outperform the broader equity market this year,” he said. “But if central banks truly are done raising rates, the next 12 months could end up being an improvement on the 12 months that just passed.”
Have a story idea or suggestion? Email [email protected].
