Bond yields are on the move again, hitting fresh multiyear highs on Thursday and sending ripples of concern through the global stock market, which fell sharply.
But some observers believe that the period of sharply rising bond yields is nearing an end, which could give a new shine to dividend stocks at a time when companies are boosting their quarterly payouts.
The latest bond moves, and the stock market’s reactions to them, are remarkable.
The yield on the 10-year U.S. Treasury bond rose above 3.2 per cent early Thursday, to a new seven-year high. The yield on the Government of Canada 10-year bond rose as high as 2.58 per cent, also a multiyear high and up nearly a full percentage point over the past year.
Stocks were hit hard, as investors worried about the bond market’s impact on stock valuations and corporate profits.
In early afternoon trading, the S&P 500 was down nearly 28 points, or 1 per cent, to 2898. The Dow Jones Industrial average fell 246 points or 0.9 per cent, to 26,582. And in Canada, the S&P/TSX composite index fell 122 points or 0.8 per cent, to 15,950 – taking the struggling index back to where it was about a year ago.
The turbulence followed some good news for the North American economy, which raised expectations for tighter monetary policy.
A new trade agreement between the United States, Mexico and Canada, announced on Monday, lifted some uncertainty that had been hanging over the economy for much of this year.
Thursday’s ADP private payrolls report for September, a precursor to the official monthly payrolls figures from the U.S. Labor Department - due Friday morning - was better than expected. And a measure of U.S. service sector activity from the Institute for Supply Management rose to a 21-year high.
Some central bankers believe this winning streak supports the need for additional interest rate hikes.
At an event in Washington on Wednesday evening, U.S. Federal Reserve chairman Jerome Powell said that interest rates are “a long way from neutral" – implying that the Fed can hike rates further before the central bank reaches the point where monetary policy is neither cooling nor stimulating the economy. The Fed has raised its key rate three times this year.
When the 10-year bond approached the 3 per cent threshold earlier this year, and then crossed it, the march higher raised alarms over how higher bond yields would raise borrowing costs, crimp corporate profits and lower stock valuations. The S&P 500 reflected these concerns, falling 10 per cent from late January to early April, before recovering.
Bonds are again driving stock market sentiment. But a number of observers believe that the current momentum in bond yields won’t last much longer, pointing to the aging business cycle and the fact that at least one engine of economic activity – recent U.S. tax cuts – has already played out.
Economists at National Bank Financial expect that U.S. economic growth will slow to 2.3 per cent in the fourth quarter, at an annualized pace, down from 3.6 per cent growth in the third quarter. They expect the economy to slow even more by the end of 2019.
Although the National Bank economists see three more Fed rate hikes ahead, the federal funds rate should top out at a range between 2.75 per cent and 3 per cent, which would put a brake on bond yields. They believe the yield on the 10-year U.S. Treasury bond will rise as high as 3.3 per cent but end the year lower, at about 3.14 per cent.
Capital Economics is also skeptical about U.S. economic growth, and yields. John Higgins, chief markets economist, believes the 10-year bond yield is close to its highest point for this monetary tightening cycle, and will fall to 2.5 per cent by mid-2019 as the U.S. economy slows.
“We think that the central bank will stop in its tracks amid signs that economic growth is slowing below its potential. And unlike investors, we suspect that the Fed will cut rates significantly in 2020 in order to try to prevent a recession," Mr. Higgins said in a note.
Dividend stocks may be an attractive place to ride out this shift. Just as dividends look less attractive as bond yields rise, they should regain some of their allure as bond yields flatten out or subside.
What’s more, companies that pay dividends have been ramping up their payouts at an impressive pace, providing an additional reason to stick with these stocks.
According to Howard Silverblatt, an analyst at Standard & Poors, the S&P 500 is on track to raise its overall dividend payout by more than 9 per cent in 2018, well ahead of the 7 per cent dividend increase in 2017 and 5.4 per cent increase in 2016.
Looking solely at companies that raised their dividends in the third quarter, the average increase was a remarkable 17.2 per cent – up from 11.4 per cent in 2017.
Rising bond yields may be fraying some nerves, but it is also creating opportunities.
David Berman