Inflation

Inflation

Dividend Stocks: Completing the Income Puzzle

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Franklin Templeton, iStock

By Les Stelmach and Ryan Crowther

Franklin Bissett Investment Management

(Sponsor Content)

It’s no secret that yields on fixed income investments have been in a prolonged slump for decades, challenging both individual investors to meet their income needs and institutional investors like pension funds and insurance companies to deliver on their obligations to retirees.

While some investors have moved further out the fixed income risk spectrum in pursuit of higher yields, others are diversifying their income sources by adding to their investments in shares of dividend-paying companies.

Dividends are playing catch-up

Despite recovering economic conditions, dividend-paying stocks lagged the overall market in 2021. Given continued uncertainties directly and indirectly related to the COVID-19 pandemic, dividend growth in general reflected some conservatism. Many factors influencing earnings growth in 2021 were sector-specific. Some industries continued to deal with subdued demand compared to pre-pandemic levels, while in other cases, regulators prohibited dividend increases at the onset of the pandemic.

Lately, however, dividend payers’ shares have performed well for several reasons:

  • Despite rising inflation, supply-chain pressures and labour shortages, corporate fundamentals have generally remained supportive as revenues, earnings and profit margins have continued to perform well.
  • Valuations for many dividend stocks are firmly anchored to those fundamentals, insulating them somewhat from market concerns over valuations in a higher-rate environment.
  • In addition to many companies initiating, restoring or raising their dividend payouts, the share prices of many dividend-paying stocks benefited from market momentum in a “best of both worlds” environment.
  • Market sentiment has shifted in response to signals from both the U.S. Federal Reserve and the Bank of Canada indicating a faster pace of interest rate increases in combination with quantitative tightening.

Dividends likely to grow

The average earnings per share growth for the Canadian S&P/TSX Composite and the U.S. S&P 500 Indices spiked last year. Dividend increases were broad-based throughout the year. Barring any major economic setbacks, we expect continued steady dividend growth from companies across many sectors. Average cash as a percentage of total assets held by constituents of the S&P/TSX Composite Index is at levels not seen in more than 20 years: another positive development for dividend growth.

In Canada, we are finding certain sectors particularly attractive:

Financials: Banks are an example of dividend growth held back by regulators from the pandemic’s onset. In 2021, even though  earnings grew, dividends were temporarily constrained; however, this restriction was lifted last November. Most recently, we have seen the Canadian banks increase dividends between 10% and 25%, but we believe there could be room for further increases. Banks retain excess capital, and at the very least, we believe the group will resume their annual pattern of increases from this point. In our view, Canadian banks are on very solid footing and offer some of the most attractive valuations.

Commodity-related: Commodity prices are high as economic activity resumes from pandemic lows, which is positive for the energy and materials sectors, and by extension, industrials. We have seen a remarkable recovery in oil prices since the precipitous drop in the spring of 2020 when the global economy shut down in response to the spread of COVID-19. At that time, a number of energy stocks had their dividends cut as the depth and duration of the economic downturn were unknown.

Since then, the oil and gas sector has staged a dramatic comeback, with higher prices boosting cash flows. Along with the recovery of prices, we also have seen a significant pick-up in dividends. Companies are employing various dividend strategies. Some prefer methodical increases to the base dividend level at a rate sustainable under a range of commodity price scenarios; others are considering variable dividends or periodic special dividend payments on top of the base dividend level. We believe boards and management teams are exercising a certain degree of caution to avoid being vulnerable if oil or gas prices experience a sharp decline in the future.

Real estate: In certain property categories (primarily retail), real estate investment trusts (REITs) had to absorb higher vacancies and deferred rent payments from tenants as stores were temporarily closed due to pandemic restrictions. These stresses often manifested as flat cash distribution profiles or, in some cases, temporary reductions in distributions. Although it’s too early to be certain of a return to historical norms across all property classes, we are seeing encouraging signs in rents and occupancy, and we note some REITs are again raising distributions.

Utilities and telecoms have maintained their dividends throughout the pandemic and we expect their dividend growth trajectories will be in line with historical experience.

Risks and opportunities

Consistent and growing dividends are characteristic of higher-quality, established companies that by definition tend to sit comparatively lower on the equity risk spectrum. It’s important to remember that like any stock, they are subject to equity market levels of volatility; but stable to growing dividends can reduce part of that risk as investors continue to receive income distributions even in a volatile market. In a rising market environment, investors could benefit both from the dividend yield and a higher stock price. Continue Reading…

Retired Money: Do Inflation-linked Bonds make sense in an era of rising interest rates?

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My latest MoneySense Retired Money column, which has just been published, can be found by clicking on the highlighted headline here: Do inflation-linked bonds make sense in an era of rising interest rates?

The topic is one that until mid 2021 received relatively scant attention: Inflation-linked Bonds and/or ETFs that own them. In Canada, these are called Real Return Bonds (RRBs) while their equivalent in the United States are called Treasury Inflation Protected Securities (TIPS). There are ETFs trading both in Canada and the US that let users own baskets of these securities.

Of course, inflation didn’t seem to be a huge issue for investors until around the summer of 2021 and then the fall, when suddenly the headlines were full of ominous new levels of inflation not seen in years or decades.

These days, traditional non-inflation bonds, or “nominal” bonds famously pay very little in interest, and net returns net of high inflation can easily end up being negative. The idea with RRBs or TIPS is that If inflation ticks above certain levels, such bonds or ETFs holding them  tack on extra interest payments roughly commensurate with the rise in the official inflation rate.

Inflation plus Rising Interest Rates

But the column addresses the question of what if the longer-term bonds held in these funds inflict capital losses when interest rates spike at the same time? That’s the problem with some Canadian RRB ETFs that hold too much in long- or mid-term bonds, and most of them do. 2021 was not a good year for funds like the iShares Canadian Real Return Bond Index ETF (XRB) or the BMO Real Return Bond Index ETF (ZRR), which lost almost 5% in the first nine months of 2021, but ended the year slightly positive.

This is less of a problem if you hold RRBs directly: Real Return Bonds issued by Ottawa have long maturities, ranging from five years out to 30 and even 40 years out. I use to own some of these directly, listed as Government of Canada Real Return Bonds, maturing in December 2021 .When I tried to find a new series at RBC Direct Investing, none seemed to be available online. I discovered you can buy newer issues by calling the discount brokerage’s bond desk. The column describes one maturing in 2026 [which I ultimately purchased, although it is now slightly under water] and a second in 2031.

US TIPS ETFs hedged to Canadian dollar

But if you want to diversify through funds, minimize interest rate risk and get exposure to both RRBs and TIPs, there’s a lot more choice with US-traded TIPS ETFs like the Vanguard Short-term TIPS ETF [VTIP], which hold mostly short-term bond maturing in under five years. Continue Reading…

Risk Management: A Four-Letter Word?

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By Noah Solomon

Special to the Financial Independence Hub

Since the global financial crisis of 2008, markets have for the most part been a one-way train. Even the precipitous decline of the Covid-crash of early 2020 was erased so quickly that several months later it seemed like little more than a bad dream.

In such a favourable and long-lasting environment, risk management has increasingly become regarded as a four-letter word. Any attempt to mitigate risk and protect investors from large losses has been a money losing proposition. It has been a drag on returns and has done little to reduce volatility. Simply stated, risk management isn’t of much use when there has been no risk to manage.

Defining a Bubble: Like Catching Water in a Net

There is no universally accepted definition of a bubble. Identifying one is part art and part science and can only be done with certainty in hindsight once a bubble has become a matter of record.

Parabolic gains in markets in and of themselves may or may not signal a bubble. Similarly, situations where valuations stand significantly higher than their long-term historical averages cannot be conclusively classified as bubbles.

Further complicating matters, bubbles tend to be accompanied (if not caused) by a broad-based mindset among investors, which by definition is difficult, if not impossible to measure or define.

Behavioral Characteristics of Bubbles: Zero Fear & Speculative Frenzy

One of the most common and powerful characteristics of bubbles is a widespread belief that stocks can only go up. Aided and abetted by historical precedent, many investors have become emboldened by growing faith in a perpetual Fed “put,” whereby the central bank will move aggressively to support (and even reverse) any significant decline in markets.

Relatedly, this complacency has led to a surge in speculative madness during which a growing number of investors have piled into riskier assets, causing parabolic gains. One does not have to look far to see several signs of such behaviour, including:

  • Meme stock madness: GameStop and AMC, two companies in declining industries which respectively rocketed up 120x and 38x from their post-pandemic lows to their 2021 highs.
  • Crypto craziness: Dogecoin, which was originally conceived as a parody, went up nearly 300x to a market cap of $90 billion, spurred by tweets from Elon Musk.
  • Electric vehicle ecstasy: Hertz’s stock surged by simply announcing that it would purchase a fleet of Teslas. Similarly, Avis tripled in a day based on the mere suggestion that it might follow suit!

The Daunting and Consistent Math of Bubbles: It’s A Long Way Down

In the world of statistics, a 2 sigma event refers to something that occurs only 5% of the time. Using this framework, a market that is 2 sigmas above its long-term trend can be considered to be in bubble territory (or at the very least quite frothy). Using the same logic, a market that stands at 2 sigmas below its long-term trajectory can be thought of as mouth-wateringly cheap (or at least as somewhat of a bargain).

Founded in 1977, Boston-based Grantham Mayo Van Otterloo (GMO) is an investment management firm with roughly $75 billion in assets under management. It is well-known for its strong track record of asset allocation. The firm successfully identified and navigated both the tech bubble of the late 1990s and the real estate/financial bubble of 2006-7.

GMO analyzed the available data over financial history across all asset classes and identified more than 300 2 sigma observations. In developed equity markets, every single one of these observations over the past 100 years has fully deflated with prices falling back to their long-term trends. This pattern strongly suggests that:

  1. The higher markets go, the lower their expected future returns.
  2. The higher markets go, the longer and greater pain investors will have to endure to get back to trend.

Importantly, if you think that the recent decline in stock prices presents a golden opportunity to scoop up cheap assets, the fact that the S&P 500 currently stands about 40% above its long-term trend should be cause for sober second thought. This prospective downside is corroborated by Warren Buffett’s favourite valuation gauge, otherwise known as the Buffett Indicator, which is the ratio of the total value of the U.S. stock market to GDP. The indicator currently stands at 193%, which is approximately 50% above its historical average.

Make Mine a Triple

Using the 2 sigma definition of a bubble, in early 2021 it looked as if we might have a standard bubble. However, as the year progressed, the 2 sigma deviation progressed into an even rarer 3 sigma anomaly, which comes with an associated increase in potential pain.

Adding to concerns, real estate assets have arguably joined the bubble-party in stocks. Houses in the U.S. stand at the highest multiple of family incomes ever: even ahead of levels that prevailed prior to the housing bubble of 2006-2007. Alarmingly, this lofty multiple is lower than the corresponding level in other countries (Australia, the UK, China, and our very own Canada). Continue Reading…

New Harvest Monthly Income ETF aims to beat inflation by combining 5 different “Best Ideas”

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Canadian retirees and would-be retirees who feel starved of high monthly income and are pressed by surging inflation may find relief in a unique new “Best Ideas” fund-of-funds Income ETF that began trading on Feb. 16th.

Harvest Portfolios Group Inc. announced on Wednesday the completion of the initial offering of Class A Units of the Harvest Diversified Monthly Income ETF, which is now trading under the ticker symbol HDIF [TSX.]

In a press release, Harvest president and CEO Michael Kovacs said the new ETF targets a high initial annual yield of 8.5% by accessing “five proven Harvest Equity Income ETFs efficiently in one single ETF.”  In a backgrounder  on its website, Harvest noted the inflation-busting 8.5% compares to a 4.5% Canadian inflation rate that ended 2021, and to the TSX’s 2.6% annual yield and S&P500’s 1.5%.

As outlined in a prospectus filed Feb. 4th with all provincial securities regulatory authorities in all Canadian provinces and territories, the innovative new ETF brings together five different Harvest “Best Ideas” in generating income, and is designed to provide Canadian investors access to a core diversified monthly income solution.

The portfolio is comprised of more than 90 large global companies diversified across these 5 equally weighted sectors: Healthcare, Technology, Global Brands, Utilities, and US Banks. The five underlying ETFs are illustrated below: There is no additional management fee apart from the MERs of the underlying Harvest ETFs. Because it’s a new fund and because of the leverage component, there is not yet an estimate of what the final MER might be. But it should be  in the ballpark of some blend of the MERs of the underlying funds: Referring to the tickers below, here are the Management Fees and MERs of the component Harvest ETFs, as of June 30, 2021:

HHL 0.85%/0.99%

HTA 0.85%/0.99%

HBF 0.75%/0.96%

HUBL 0.75%/0.99%

HUTL 0.50%/0.79%

 

The net result is a collection of global stocks that are allocated in the following sectors (a comparable geographical breakout is not yet available):


In addition to high monthly cash distributions the fund provides the opportunity for capital appreciation by investing, on a levered basis, in a portfolio of ETFs that engage in covered call strategies.  Harvest says the maximum aggregate exposure of the ETF to cash borrowing will not generally exceed approximately 33% of the ETF’s net asset value.

For additional information, visit www.harvestportfolios.com

What to do — or NOT do — during the next Bear Market

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Photo credit Lowrie Financial/Canva

By Steve Lowrie, CFA

Special to the Financial Independence Hub 

If you won a round-trip ticket on a backward-moving time machine, what period would you visit? One I’d probably skip would be April 2018. Why bother, since the market climate wasn’t all that different from today? Consider this commentary:

“U.S. stock markets ended in the red on Thursday with all three major indexes declined broadly. Thursday’s earnings results failed to live up to investor’s [sic] expectations despite remain[ing] strong. Moreover, a spike in the yield of 10-year Treasury Note also panicked investors. However, the markets shed some of its losses in the final hour of trading …” blah blah blah.
— Nasdaq Stock Market News for April 20, 2018

Sound familiar? While we now know no bear market materialized, some investors were questioning whether it was time to get out, while the gettin’ seemed good. To explain why market-timing is always a bad idea, I published a post then, to review the timeless tenets of evidence-based investing.

Returning to early February 2022, we are once again seeing some volatility in bond and stock markets. Not surprising, given the strong equity returns over the past 18 months and the fact that most central banks have indicated they will be raising interest rates to tackle inflation.

Will the bear awaken this time? Maybe yes, maybe no. Either way, my advice isn’t going to change, so let’s revisit what I wrote back then.

But first, let’s talk about you. What sort of investor are you?

I enjoyed a recent post from “The Psychology of Money” author Morgan Housel, who pointed out that it’s misleading to “lump everyone into one category called ‘investors’ and view them as playing on the same field called ‘markets’”.

Two people can have vastly differing time horizons, goals, and objectives. When you multiply this by millions of market participants, you see how inaccurate it is to paint everyone with the exact same “investor” brush.

So, let’s be clear: Are you investing to complete your long-term, multi-generational financial journey? If so, we write our posts for you. And for you, Housel hit the nail on the head with this observation, with which I fully agree:

“Bubbles do their damage when long-term investors playing one game start taking their cues from those short-term traders playing another.”

If you are a short-term trader, I wish you all the best in your market activities. However, you probably won’t find my pointers all that helpful. You may prefer Reddit instead.

In that context (if you’re still here), let’s look back at my thoughts from April 2018 …

As we write this piece in April 2018, overall market temperatures have been relatively mild for quite a while. Many newer investors have yet to weather a perfect market storm, and even those who have may have forgotten how panic-inducing they can be. But a bear market could be on the horizon.

To help you prepare for the next market downturn, or respond if you’re reading this during one, here are 10 timely actions you can take when financial markets are tanking to get your through to market recovery. Frankly, these tips are valid during any stage of the financial markets.

  1. Don’t panic (or pretend not to). It’s easy to believe you’re immune from panic when the financial sun is shining, but it’s hard to avoid indulging in it during a bear market crisis. If you’re entertaining seemingly logical excuses to bail out during a steep or sustained market downturn, remember: it’s highly likely your behavioral biases are doing the talking. Even if you only pretend to be calm, that’s fine, as long as it prevents you from acting on your fears before you see the light at the end of the tunnel with market recovery.

Every time someone says, ‘There is a lot of cash on the sidelines,’ a tiny part of my soul dies. There are no sidelines.” – Cliff Asness, AQR Capital Management

  1. Redirect your energy. No matter how logical it may be to sit on your hands during market downturns, your “fight or flight” instincts can trick you into acting anyway. Fortunately, there are productive moves you can make during a bear market instead – such as all 10 actions here – to satisfy the itch to act without overhauling your investments at potentially the worst possible time.

My advice to a prospective active do-it-yourself investor is to learn to golf. You’ll get a little exercise, some fresh air and time with your friends. Sure, green fees can be steep, but not as steep as the hit your portfolio will take if you become an active do-it-yourself investor.” – Terrance Odean, behavioral finance professor

  1. Remember evidence based investing. One way to ignore your self-doubts during market crises is to follow what decades of practical and academic evidence have taught us about investing: capital markets’ long-term trajectories have been upward. Thus, if you sell when markets are down, you’re far more likely to lock in permanent losses than come out ahead. Trust evidence based investing principles.

Do the math. Expect catastrophes. Whatever happens, stay the course.” – William Bernstein, MD, PhD, financial theorist and neurologist

  1. Manage your exposure to breaking bear market news. There’s a difference between following current events versus fixating on them. In today’s multitasking, multimedia world, it’s easier than ever to be inundated by late-breaking news. When you become mired in the minutiae, it’s hard to retain your long-term perspective.

Choosing what to ignore – turning off constant market updates, tuning out pundits purveying the latest Armageddon – is critical to maintaining a long-term focus.” – Jason Zweig, The Wall Street Journal

  1. Revisit your carefully crafted investment plans (or make some). Even if you yearn to go by gut feel during a financial crisis, remember: You promised yourself you wouldn’t do that. When did you promise? When you planned your personalized investment portfolio, carefully allocated to various sources of expected returns, globally diversified to dampen the risks involved, and sensibly executed with low-cost funds managed in an evidence-based manner. What if you’ve not yet made these sorts of plans or established this kind of portfolio? Then these are actions we encourage you to take at your earliest convenience. Continue Reading…