Frothy markets point to dividends
With rocketing stock market gains forecast to wane in the second half of the year, investors should pivot into dividend-paying stocks from growth or value equities, CIBC Capital Markets says in a new report.
“Dividends are likely to take on increased importance as equity returns moderate,” CIBC analysts said a report this week. “With the current low interest rate environment, we expect dividends to become increasingly relevant for investors.”
The research team led by Ian de Verteuil recommends choosing Canadian stocks over their U.S. counterparts because the average spread on yields between the two country’s equities has widened to 120 basis points (bps) from an average of 40 bps over the past 30 years.
Plus, four of the more stable industries — financials, communications, utilities and pipelines — on the Toronto Stock Exchange’s S&P/TSX composite index have boosted their share of the $75 billion a year paid in dividends to investors to 71 per cent compared with 54 per cent in the early 1990s, the researchers say.
Growth and value stocks — shares that might have collapsed during the pandemic, but have soared this year with strong earnings as lockdowns eased and economies rebounded — won’t be able to continue their rise at the same pace.
As if to prove the CIBC point, this week the S&P/ TSX fell to its lowest level since last month, in part hampered by rising COVID19’S Delta variant cases and word that the U.S. Federal Reserve was mulling decreased support for the economy this year as rising employment neared a target.
On Thursday, all the main indexes in Canada, United States and Europe were receding, while Asian equities dropped to their lowest level this year. Global central bankers are set to meet this month at their annual retreat in Jackson Hole, Wyoming, which could give an indication of where monetary policy is heading.
Of importance to stocks is how the U.S. Fed will reduce or taper the US$120 billion in Treasury bonds and mortgage-backed securities it buys each month to inject cash into the economy.
Investors will also have to contend with when central banks will eventually raise interest rates from record lows at some point. Rates are often increased as a means to control inflation. The Bank of Canada’s inflation target is between one and three per cent while the country’s annual inflation rate rose to 3.7 per cent last month, the highest in a decade, while it stood at 3.5 per cent in June in the United States. However, current rising prices in most economies are largely seen as transitory while supply chain kinks are ironed out after pandemic lockdowns.
Nonetheless, some market watchers are awaiting a pullback in stock prices, and CIBC is warning investors to prepare for a change in strategy.
“Price returns have been the name of the game in recent years,” CIBC said. “Given the unusually strong returns over the past handful of years, investors may be lulled into ignoring the importance of dividends.”
Research showed S&P/ TSX dividends appear to be “more resilient than in the past.” About a third of S&P/ TSX members have consistently increased dividends over the past five years, compared with 20 per cent in the early 2000s.
The bank included a list of what it called Canadian “Dividend Dynasties” — companies that have increased their dividends more than 10 times over the past decade. Ranked by their dividend’s compound annual growth rate, the top five are Restaurant Brands International Inc. (parent company of Tim Hortons), property company Brookfield Asset Management Inc., software firm Enghouse Systems Ltd., pipeline company Enbridge Inc., and packager CCL Industries Inc.
CIBC issued special praise for sixth place Canadian Natural Resources Ltd. for invariably raising its dividend despite being a crude producer enduring an oil price slump that made it the worst-performing company on the list of 33.
“We find it particularly impressive that CNQ has been able to consistently grow its dividend over this period,” the bank research team wrote.
CNQ’S resilience is even more impressive as energy and materials as sectors accounted for about 80 per cent, or $21 billion, of the $27 billion in total dividend cuts over the past 15 years, the bank said.
Most of the resource companies, which compose a large proportion of the S&P/ TSX market capitalization, “are price takers, and are dependent on volatile commodity prices,” CIBC said. “As such, this makes regular, consistent dividends more difficult to support.”
Rounding out the top 10 on the list are car parts maker Magna International Inc., gold miner Franco-nevada Corp., Canadian National Railway Ltd. and grocer Metro Inc.