It's déjà vu all over again. About this time two years ago, interest-sensitive securities were battered after comments by Ben Bernanke, then chair of the U.S. Federal Reserve Board, that the Fed would soon start tapering off its quantitative easing program.
The "taper tantrum", as it came to be known, rocked the markets. Interest sensitive securities plunged in price as bonds, preferred shares, REITs, utilities, and telecoms were hit.
In case you haven't noticed, we're seeing a similar phenomenon now, albeit in a more muted form. Once again, the culprit is the Fed, which appears to be set on embarking on its first tightening cycle since the crash of 2008 forced it to cut interest rates to near zero. As matters stand now, it looks like the first rate hike will come sometime this fall unless the American economy falls on its face in the interim.
But, as usual, the markets aren't waiting for a formal announcement. The retreat in the prices of interest-sensitive securities is well under way. Interestingly, it is hitting Canadian stocks hardest, even though the Bank of Canada is much farther away from raising rates than the Fed is. That's because the Fed influences securities yields more than our own central bank.
The REIT sector has suffered the most damage so far. May was a terrible month for these securities with the S&P/TSX Capped REIT Index falling 5.6 per cent. REITs had been performing well prior to that but the May debacle, which carried on through the first two weeks of June, wiped out all the year to date gains in the sector. As of the close on June 11, the S&P/TSX Capped REIT Index was showing a year-to-date loss of 0.5 per cent.
Every REIT in the sub-index shows a similar chart pattern, with a downward movement in May and early June. Calloway REIT (CWT.UN-T) and H&R REIT (HR.UN-T) held up better than most during the month but even they are well down from their 52-week highs.
Utilities stocks were down 3.2 per cent as a group during May and were off 4.8 per cent for 2015 as of June 11. However, a few bucked the trend including Algonquin Power and Utilities (AQN-T) and Emera Inc. (EMA-T).
Preferred shares were also hurt, although not as badly. That sub-index was down just 0.9 per cent in May, but the year-to-date decline is a very unhealthy 9.2 per cent.
Although REITs, utilities, and preferreds are the most high profile of the interest-sensitive securities on the TSX, all dividend-paying stocks are vulnerable. A look at the S&P/TSX Composite High Dividend Index shows how the pain is being spread across the board. It is composed of 75 dividend stocks from all sectors, with the heaviest weightings in energy and financials. That sub-index was down 5 per cent in May, and is in the red by 4.1 per cent year-to-date.
We're seeing a similar story on Wall Street. The Dow Jones U.S. Real Estate Index lost 2.1 per cent during early June and was off 4.1 per cent for the year as of June 1. The Dow Jones Utility Index eked out a 0.1 per cent gain during May but then dropped 2.5 per cent in early June for an 8.5 per cent loss for 2015 to date.
We are likely to see more of this pain over the summer as the hour for the Fed rate hike approaches. That will mean more capital losses on interest-sensitive securities you own. The flip side is that dividend yields will rise as share prices fall, making the cash flow from income stocks more attractive. But don't rush to buy. Once the Fed starts hiking rates, it will probably continue to do so for some time. That will drive the prices of these securities even lower.
Of course, you can decide to dump all the interest-sensitive stocks out of your portfolio and wait. But the tightening cycle could continue for a few years, during which time you'd lose all the dividends. Moreover, the sell-off may have been front-end loaded. Future market reaction and price declines may be more modest.
On balance, my advice is to continue holding any good-quality interest-sensitive stocks in your portfolio but don't add more at this stage. Wait for the bargains to emerge.