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Some of Canada’s foremost dividend stocks are down since bond yields took off. But the damage is slight
Investors are waking up to the threat posed by surging bond yields, if the downturn in Canadian telecoms, utilities and pipelines is any indication. Is this downturn an opportunity or the start of something worse?
The three sectors were doing okay until the end of July. The price of crude oil was below US$80 a barrel then, central banks were holding their key interest rates steady and government bond yields weren’t raising any alarms. A little over two months later, though, things look considerably different. The price of West Texas Intermediate, or North American crude, rose above US$100 a barrel in September.
That same month, the U.S. Federal Reserve, wary of inflation, raised its key interest rate and signalled more hikes could follow. Most alarming, the yield on the 10-year U.S. Treasury bond – a benchmark for the global bond market – surged to a 24-year high above 5.3 per cent early Thursday. Even though it retreated Thursday afternoon, the yield is still significantly higher than it was during the inflation scare three years ago.
Rising bond yields can diminish the appeal of dividends, raise borrowing costs and add a dark cloud to the economic outlook. Even though the S&P 500 isn’t far off its record-high in August, bond yields could weigh on valuations. In Canada, a number of stocks stand out for showing early vulnerabilities. TC Energy Corp., the pipeline operator that rallied to a record high in July, has retreated more than 17 per cent since then.
Fortis Inc., the utility, is down 10 per cent from its high in July. BCE Inc. is exploring new multiyear lows this week. And Telus Corp., which appeared to be attracting some contrarian investor interest ahead of new leadership at the telecom, has slumped 26 per cent since the end of July. Some income-loving investors might relish the sell-off as an opportunity to add higher-yielding stocks to their holdings. Fortis is yielding 3.4 per cent, up from about 3 per cent in July. TC Energy is yielding 4.3 per cent, up from 3.5 per cent . Add regular dividend increases and the stocks – along with plenty of other dividend stalwarts – might look attractive over the long term.
And yes, all three stocks face challenges largely unrelated to the bond market. Telus is embarking upon restructuring efforts, which includes slashing its quarterly dividend, to improve its balance sheet. TC Energy may be losing some appeal with popular opposition to data-centre expansion. And Fortis had become an expensive stock before the dip, with a price-to-earnings ratio above 22.
That is conspicuously high for a slow-growing utility. But the bond market is likely playing a role here, too.
“With long-term Treasury yields at their highest level since the early 2000s, the pressure on other asset classes, including equities, is increasing,” Jonas Goltermann, chief markets economist at Capital Economics, said in a note last week. This isn’t solely an inflation story, as it was in 2022 and 2023. This time, rising government deficits and soaring debt from hyperscalers are contributing to rising bond yields. These trends are unlikely to slow any time soon.
They could get worse, especially in the United States, where the annual budget deficit has risen to 6 per cent of the country’s gross domestic product. Canadian dividend stocks, though down from recent highs, aren’t reflecting a whole lot of concern. The Big Six banks stand out as a sector that remains expensive . The group is down just 7 per cent from highs in mid-July.
That’s not even a correction, usually defined as a downturn of 10 per cent. The dip has merely trimmed the group’s gains over the past two years to 82 per cent. The average dividend yield – at just 2.4 per cent – is not exactly greed-inducing. Perhaps investors are still weighing the pros and cons of rising interest rates: They can fatten margins on bank loans but also raise the number of defaults.
One thing to keep in mind? The last time bond yields approached today’s lofty levels, in October, 2023, stocks were floundering. The average dividend yield for the Big Six banks was 5.7 per cent, or well over double the current payout. Similarly, Fortis’s dividend yield was a fatter 4.2 per cent and TC Energy’s yield was an eye-popping 8.5 per cent.
Investors are now growing cautious as bond yields rise. Bargain hunting, though, might require some patience.
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