Autumn is in the air and a nation waits with bated breath for the return of its beloved pastime – dividend investing.
It’s been a rough few years for dividend-paying stocks and the investors who follow them with near-cultish devotion.
Rampant inflation and spiking interest rates spoiled what was one of the most reliable trades in Canadian stocks.
Now dividend diehards have reason to believe again. High-yield stocks have started to make up some of their lost ground. And great fortunes that found refuge in savings accounts and GICs are beginning to rotate back into the dividend stocks from whence they came.
The Bank of Canada is now three interest-rate cuts deep into its path of easing financial conditions, and rates on savings vehicles are coming down across the board. The days of easy 5 per cent cash are fading fast.
Unsurprisingly, enthusiasm for cash and cash equivalents is waning. In August, investors pulled about $420-million from money market mutual funds, according to the Investment Funds Institute of Canada (IFIC).
While that’s the biggest net outflow in nearly three years, it’s a mere trickle that could easily become a torrent.
Canadians have amassed an incredible hoard of cash since the COVID-19 pandemic began. Economists consider a portion of that stockpile to be “excess savings” totalling, at the high end of calculations, $500-billion. (For perspective, that’s roughly one-eighth the market value of the entire Toronto Stock Exchange.)
Now, many Canadian households have a very good reason to keep a little extra socked away. In May, the Bank of Canada estimated that half of outstanding mortgages had yet to renew at higher rates.
But much of the savings glut is simply money that chased a generational opportunity for yield beyond the confines of the stock market.
Up until a few years ago, dividend stocks were the only game in town for income investors. There was a very simple reason for this: Yields outside of the stock market were trash.
In late 2020, a GIC would get you less than 1 per cent on a one-year term. Three-month Canadian treasury bills carried a yield at the time of around 0.1 per cent.
This punishing era for savers was the product of four decades of declining interest rates – a financial megatrend that shaped modern global capital markets. Remember when Austria issued a 100-year bond yielding a whopping 0.9 per cent?
Not only were dividends the no-brainer choice for yield, they also performed very well in Canada for a very long time.
Between 1977 and 2023, an investment in high-yielding Canadian equities would have grown at more than four times the pace of the same amount of money parked in the broader Canadian stock market, according to data compiled by Norman Rothery, founder of StingyInvestor.com.
For a couple of generations, that was the status quo. It went on so long, everyone assumed it to be the permanent order of the financial world.
Then suddenly, you could get 5 per cent – even 6 – with virtually no risk. Investors gorged on easy returns. Since the end of 2021, Canadian money market mutual funds and ETFs have seen their assets swell by nearly $50-billion, or 2.5 times, IFIC data show.
Throw in the vast sums residing in term deposits such as GICs, and there is a large surplus of savings in Canada that naturally belongs in dividend stocks, according to CIBC World Markets’ head of portfolio strategy, Ian de Verteuil. He pegs the excess at $200-billion.
The unwinding of the pandemic-era yield trade is starting to take shape. Fund flows appear to be at a turning point. And everywhere you look, rates and yields are coming down. The U.S. Federal Reserve is fresh off a 50-basis-point cut – its first reduction in policy rates since March, 2020. The market is pricing in at least another 75 basis points in cuts this year.
One-year GIC rates are now at 4.75 per cent or less at alternative banks, down from a peak of 6 per cent. And the yield on Government of Canada five-year bonds has dropped from a high of 4.4 per cent to 2.7 per cent.
Now, there’s life in dividend stocks. The Dow Jones Canada Select Dividend Index has gained 15 per cent since the end of June, after spending the previous two-and-a-half years going nowhere.
At this point, some Canadian investors may need reminding why they once loved dividend stocks so much. They have tax advantages, they tend to hold up well in market sell-offs and they tend to grow over time faster than inflation, Craig Basinger, chief market strategist at Purpose Investments, wrote in a recent report.
Plus, Canadian dividend yields are attractive these days, more so as interest rates elsewhere continue to fall. “Generally, dividends are cool again,” Mr. Basinger said.
So forget hockey, which hasn’t exactly rewarded its Canadian fans for their loyalty over the last 30 years. Instead, get some friends, some beers and maybe some body paint, and head down to the Toronto Stock Exchange to show your support for Team Dividend.