Dividend stocks headed into stormy stretch

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A confluence of monumental catalysts should make for a raucous post-Thanksgiving home stretch that may well have investors longing for a quieter, warmer time.

The placid summer trading season was but a brief respite in an otherwise erratic year, which yet has its biggest scores to settle.

Chief among them, as far as the market is concerned, is the election of the next U.S. president, a pivotal earnings season that could bring an official end to the longest profits recession since the global financial crisis and a potential U.S. rate hike.

The potential localized effects on portfolios are considerable, and much scrutiny here will be reserved for one subset of the stock market close to the hearts of many Canadian investors: dividend stocks.

A recent sell-off in rate-sensitive stocks in the United States and Canada has coincided with an updraft in long-term interest rates, as the monetary stimulus that has suppressed yields globally for years comes increasingly into question.

And with the U.S. Federal Reserve now expected to raise its policy rate in December, Canadian investors are again being cautioned against an indiscriminate appetite for income equities.

"Just because a company has a good dividend doesn't mean it's a strong company," said Mike Newton, director of wealth management and a portfolio manager at ScotiaMcLeod. "In a rising rate environment, you kind of want a business that's growing and has strong cash flow. They're going to be less sensitive to rising rates."

The performance that Canadian investors have come to expect from domestic dividend champions has faltered of late.

Those sectors traditionally most generous with dividends – utilities, telecoms and real estate – have been the worst-performing components of the S&P/TSX composite index for the past two months or so, aside from the mining sector, which has been roiled by steep losses in precious metals prices.

Since late July/early August, those three rate-sensitive Canadian sectors have declined by between 5 per cent and 10 per cent. The trend is even starker in the United States, where the same three component sectors of the S&P 500 have all dropped by double digits since the summer.

Increasing concerns that mass quantitative easing has become ineffective and might undermine financial stability have pumped up the pressure on rate-sensitive sectors.

Meanwhile, Friday's U.S. jobs report for the month of September, which missed expectations, was still strong enough to raise the chances of a Fed hike in December to around 70 per cent, according to futures contracts.

While investors have come to rely on the stock market for income in an era of meagre interest rates, rising yields make dividend stocks relatively less attractive.

The market seems to have converged on the belief that interest rates might never increase, DoubleLine Capital's Jeffrey Gundlach said at the Grant's Interest Rate Observer conference in New York on Tuesday. "In the investment world, when you hear 'never,' it's probably about to happen," Mr. Gundlach said.

And when the rate environment undergoes a sustained change, stocks with high dividend payouts can very quickly fall out of favour, Bespoke Investment Group said in a note.

"When you are considering an investment in a dividend-paying stock, if your only reason for the decision is because it pays a good dividend, you should probably look elsewhere."

Some analysts feel that the Fed will also have greater licence to raise rates once the November election is done with, which itself has the capacity to move markets over the rest of the year.

It's difficult to assess Republican nominee Donald Trump's economic and trade proposals, which have varying degrees of plausibility. But his platform has little support among economists, who generally say Mr. Trump's protectionist stance would have negative consequences for growth.

"It stands to reason that the risk of a Trump presidency might adversely affect stock prices by raising the premium for risk demanded by equity investors," Macroeconomic Advisors, a St. Louis-based research firm, said in a note. The report said a Trump win would send U.S. stocks down by about 7 per cent, which would put the S&P 500 in negative territory on the year.

On the other hand, Matthew Barasch, RBC's head of Canadian equity strategy, argued that there is little to fear from a Trump victory in terms of Canadian stocks, which might see flow-through benefits from lower U.S. tax rates, increased infrastructure spending and a pro-oil platform.

"We believe the sum total of Mr. Trump's policy proposals would be positive for Canada and Canadian stocks, at least for a time," Mr. Barasch wrote in a recent report.

In any event, the odds of a Hillary Clinton victory in November have risen to close to 80 per cent, according to FiveThirtyEight.com, statistician Nate Silver's data analysis site, on Friday afternoon.

If that holds up, a relief rally could lift U.S. stocks by around 4 per cent, Macroeconomic Advisors said.