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Stock Trends

Preferred-share ETFs feel interest-rate pressure Add to ...

The Stock: Claymore TSX Pref. Share ETF

Recent price: $16.12

Trend: It is rare that an investor can confidently proclaim anything with certainty, but in the current environment this can be said without pause: interest rates will rise. Of course, knowing precisely when short-term interest rates begin to creep up remains as the million-dollar nugget of wisdom. Although the Bank of Canada has started to posture toward impending rate hikes, the U.S. Federal Reserve stands pat over a fragile economic recovery. Eventually, though, fear of snuffing growth must give way to the monetary reality presented by an extended period of exceedingly low rates.

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The stock market has already given us its verdict on the matter. The demand for preferred shares is often a good barometer of the mood among interest-rate sensitive investors. The prices of preferred shares have been falling over the past three months, with the S&P/TSX Preferred Share Index sprouting a slow leak of negative moves for 11 of the last 15 weeks. At the beginning of the year almost all TSX preferred shares were categorized as Stock Trends Bullish. In recent weeks scores of them have turned Stock Trends Bearish.

The Trade: Among the crop of new Stock Trends Bearish issues is the Claymore S&P/TSX Preferred Share ETF. Readers of this column will recall this exchange-traded fund's bullish profile in mid-August of last year, a time when many preferred shares were scaling to 52-week highs. However, that positive environment of advancing share prices for higher-yielding securities has given way to the reality of approaching upward moves in short-term interest rates.

The income stream represented by the dividends of preferred shares must compete with the interest-rate environment, much like bonds. As rates increase, the price of fixed-income securities and preferred shares must drop so that the yield of the income stream purchased compares favourably with the prevailing interest rates. This inverse relationship also shows in the recent bearish moves of Government of Canada and corporate bond ETFs.

Preferred shareholders will continue to feel the pressure of falling prices, as will shareholders in the common stock of other interest-rate sensitive sectors like electrical utilities. Holders of the Claymore S&P/TSX Preferred Share ETF who bought last year at a yield near 5 per cent will be looking to navigate toward better returns as rate changes clip away at the fund.

The Upside: Advising on the merits of fixed-income investments is beyond the scope of this trend analysis. This profile simply points out that changes in interest rates demand that many conservative investors not normally inclined to trading activity will be forced into action. Some preferred shares may be more appealing than others now. Issues of BCE Inc., Brookfield Asset Management Inc., and Thomson Reuters Corp., for example, are showing relative strength among the TSX preferred-share group. As well, there are bond ETFs that will compete for income-focused investors, along with some performing income trusts in the resource, real estate and transportation sectors.

The Downside: Most of the portfolio holdings of this Claymore preferred-share fund are in the financial sector, the best performing TSX group in the past 13 weeks. Price support for the fund could be at $16, near the present level, accounting for a quarter of a percentage point hike in the bank rate as the yield on the fund approaches 5.25 per cent, up from the 5 per cent it yielded at the beginning of the quarter.

Skot Kortje has been analyzing stock market trends for 15 years using trend analysis. His Stock Trends indicators have been published by The Globe and Mail since 1995. For more go to Stocktrends.ca

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