This is what was supposed to have happened: A recovery in global markets, led by the United States, would finally push up interest rates. Bond yields and rates on money-market funds and bank deposits would rise, making them more appealing to income-oriented investors. In turn, dividend-paying stocks would lose appeal, because the downside risk of equities couldn't justify their single-digit yields.
Maybe it'll still happen in 2015, as was widely thought. But it sure didn't start this week.
Instead, all the relevant markets reversed course. Equities sold off and interest rates fell as bond prices rose. And, as a result, there was a sharp increase in the number of stocks, in Canada and particularly in the U.S., with dividend yields that beat 10-year government bonds.
Many investors will look back on this week and see a bloodbath. Some, who feel this is a blip, rather than a first step to a market collapse, will see it as a chance to buy.
"People are panicking and getting out of all equities, good and bad," says Renato Anzovino, manager of the Heward Canadian Dividend Growth Fund. "Nobody likes when the markets go down, but we've been in a higher cash position than normal, and we're using this as an opportunity to add to positions of what we think are great quality companies [whose shares] have come down."
First, let's review some basic math. As investors buy bonds, driving their prices up, yields decline. That's certainly what happened this week, as investors stampeded into nearly risk-free government bonds and sold off their stocks.
As investors sell dividend-paying stocks as part of a broad equity selloff, their prices decline and the dividend yield, the dividend expressed as a percentage of the stock's price, rises.
When these things happen simultaneously, the dividend yields of blue-chip stocks rise as bond yields fall, providing a more appealing return. Mr. Anzovino's fund now yields an average of about 3.25 per cent, or more than 50-per-cent higher than the rate on the 10-year Canadian note.
"There are no stocks out there that are risk-free, but the ones I focus on are companies with recurring revenue and the ability to grow profits on a regular basis," Mr. Anzovino says.
"In Canada, we have some high-quality stocks paying dividends yielding 2.5 per cent to 3.5 per cent, and with the dividend tax credit, you're getting a bond equivalent of over 4 per cent. That's really, really interesting."
Here are some numbers that show just how dramatic the past few weeks' action has been. At the beginning of 2014, there were 92 stocks in the Standard & Poor's 500 that had a dividend yield higher than the 3.03 per cent rate on a 10-year Treasury note. (The 10-year note is a better comparison than a 30-year note, because 10 years is a far more reasonable holding period for a long-term investor in equities.)
Even as the markets climbed in 2014, the 10-year rate fell, so 134 stocks beat the note as of Sept. 19, the S&P 500's high. But at the close of Thursday's trading, a little less than a month from that high mark for equities, 86 more stocks have joined the list, bringing the number of bond-beaters to 220. (All of these results come courtesy of the screening tool on S&P Capital IQ.)
The results are a little less dramatic in Canada, where there's a greater emphasis on healthy dividends among the country's blue chips. (A greater proportion of the S&P/TSX 60 pays dividends, and the dividends are relatively larger, than the members of the S&P 500.).
At the beginning of the year, 31 members of the TSX 60 topped the 2.76-per-cent rate on the 10-year Canadian note. With the rate dropping to 1.93 per cent Thursday, that number has now climbed to 38.
"We have been though an unprecedented decline in overall interest rates. It was my call, and many peoples' call, that rates would rise in 2014, so egg on our faces for getting it wrong," said John Stephenson at Stephenson & Co. Capital Management. "But it misses the broader point that rates will at some point go up. They have to. And when they do, your fixed-income investments will lose money and lose money big."
If all of this sounds familiar, it's because it's not a new theme. Our Vox column noted this phenomenon in August, 2011, soon after Standard & Poor's downgraded the United States' credit rating and stocks swooned. At that time, the 10-year note yielded a then-record-low 2.14 per cent – the same as Wednesday – and more than 200 stocks' dividend yields beat it out.
It got even better in June, 2012, when the 10-year dipped to 1.5 per cent. More than 300 companies beat that mark with their dividend yields, we noted at the time.
Even with the recent pullback in the S&P 500, the index is still up roughly 60 per cent and 45 per cent, respectively from those two columns. Neither predicted such stellar returns; both warned, in fact that stocks could continue to slide.
But the advice then is apropos once again: "The price of safety is high. The price of potential equity returns has gotten lower. Choose according to your needs."
These members of the S&P/TSX 60 couldn't beat the rates on the Canadian 10-year government bond when 2014 began. Now, owing to market forces and, in some cases, an increased payout, their dividend yields exceed the government-bond rate.
- Bombardier (2.79 per cent)
- Cameco (2.15 per cent)
- Canadian Natural Resources (2.33 per cent)
- Manulife Financial (3.09 per cent)
- SNC-Lavalin Group (2.01 per cent)
- Suncor Energy (2.97 per cent)
- Talisman Energy (4.08 per cent)
Source: Standard & Poor's Capital IQ.
Globe app users click here for chart showing U.S. 10-year bond yield, government of Canada bonds, S&P/TSX 60 and S&P 500
David Milstead