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When the going gets tough for stocks, bonds take the edge off.

This basic rule of investing has been validated yet again in the recent stock-market decline. The dividend stocks and preferred shares some investors have used as a higher-yielding substitute for bonds have provided little comfort.

The S&P/TSX composite index lost 5.9 per cent on a total return basis (share price changes plus dividends) in February, the month in which the recent market decline really started to bite. For the first two months of the year, the index was down 4.2 per cent. Meantime, the FTSE Canada Universe Bond Index gained 0.7 in February and was up 3.6 per cent for the year to date. With stocks falling, money flowed into bonds and generated some decent total returns for bonds (interest plus changes in price).

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Stocks fall, bonds rise. We’ve seen it over and over. Now, what about the bond substitutes, dividend-paying common shares and preferred shares?

Preferred shares have been on the defensive for a while now, and early 2020 offered more of the same. The S&P/TSX Preferred Share Index was down 3.4 per cent for both February and the year to date. The Solactive Laddered Canadian Preferred Share Index, a benchmark for rate-reset preferred shares, lost 4.1 per cent in February and was down 4.3 per cent for the year to date. Dividend stocks had a rough February, as judged by the 6.3-per-cent loss for the S&P/TSX Canadian Dividend Aristocrats Index (it lost 4.2 per cent over the first two months).

Hold dividend stocks as equities for sure, particularly dividend growth stocks. But as a substitute for the stabilizing influence of bonds, they’re a fail. The same applies doubly for preferred shares, which could be today’s twitchiest, most high-strung asset class.

Most preferred shares are rate resets, which have their dividend changed every five years to reflect changes in five-year Government of Canada bond yields. Five-year Canada bond yields have recently fallen to a bit above their record low at 0.5 per cent in early March, which presents the risk that some rate-reset preferreds will be reset to provide lower yields.

Hold preferred shares for tax-advantaged dividend income in non-registered accounts, not as a substitute for bonds. They’re awful for that.

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