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After more than two years of being overlooked, dividend-paying stocks in Toronto are regaining favor among Canadian investors. According to a recent report by the Canadian Imperial Bank of Commerce (CIBC), this shift in investment strategy is set to intensify as short-term interest rates in the country continue to decline.
“A rotation back into high-yielding equities such as utilities, REITs, and communications is just beginning,” wrote Ian de Verteuil, an analyst at CIBC, in a research note released on Sunday. The bank’s analysis suggests that if interest rates continue their downward trajectory, Canadian investors could channel as much as $220 billion (US$161 billion) into dividend-paying stocks as they move away from fixed-income products.
Dividend Stocks Regain Appeal as Interest Rates Fall
During Canada’s period of higher interest rates, dividend-paying stocks were largely neglected by investors who sought better returns in other areas, such as term deposits, high-interest savings account ETFs, and technology stocks. This shift in focus contributed to the underperformance of the S&P/TSX Composite High Dividend Index compared to broader Canadian and U.S. markets throughout 2023 and into 2024, both in terms of simple price appreciation and total return.
The situation is now changing as the Bank of Canada has initiated its easing cycle, beginning with rate cuts in June. With additional cuts anticipated in September and October, investors are increasingly looking to dividend stocks, which are historically known for providing steady income, especially in a lower interest rate environment.
Challenges in Finding Yield in Canada
The Canadian market has long presented challenges for investors seeking yield, a problem highlighted by de Verteuil in his report. Unlike the United States, where investors have a broad range of options for high nominal yields, including a robust municipal bond market and a diverse high-yield bond market, Canada offers fewer alternatives. As a result, when Canadian rates peaked, approximately $200 billion in funds were redirected into fixed-income products that traditionally would have been invested in high-yielding equities.
Despite the renewed interest in dividend-paying stocks, de Verteuil cautions that many of these sectors are still facing unique challenges. For example, communications stocks are contending with aggressive price competition and regulatory hurdles, real estate companies are dealing with the long-term impacts of the COVID-19 pandemic, and banks are grappling with rising loan losses.
Positive Momentum in Real Estate and Utilities
Nonetheless, the easing of interest rates has already started to impact the performance of certain high-yield sectors positively. In July, the real estate and utilities sectors saw significant gains, rising 11% and 7.8%, respectively. This positive momentum suggests that investors are beginning to rotate back into these sectors, capitalizing on their high yields as interest rates decline.
CIBC’s analysis predicts that as the Bank of Canada continues its rate-cutting cycle, demand for high-yielding equities, particularly in the utilities, REITs, telecoms, and financial sectors, will strengthen. This renewed interest is expected to equate to 15% of the market capitalization of these sectors, potentially leading to further gains in the coming months.
