(Bloomberg) -- Investors are starting to plow funds into Toronto’s out-of-favor dividend-paying stocks after more than two years of antipathy, according to Canadian Imperial Bank of Commerce. It’s a trend that promises to grow as short-term interest rates in the country continue to be scaled back.
“A rotation back into high-yielding equities such as utilities, REITs and communications is just beginning,” Ian de Verteuil, an analyst at the bank, wrote in a research note Sunday. If rates continue to fall, his team expects Canadian investors to pour $220 billion (US$161 billion) of funds into dividend-paying stocks as they shift away from fixed income-linked products.
During Canada’s higher rate regime dividend-paying equities were passed over as investors found better returns in term deposits, high-interest savings account ETFs and technology stocks. That’s driven the S&P/TSX Composite High Dividend Index to underperform the broader Canadian and U.S. markets in 2023 and so far in 2024 on both a simple price appreciation and total-return basis.
“Canadian investors have always struggled to find yield,” de Verteuil wrote. “Unlike the US, there are very few options for ‘high’ nominal yield – there is no Canadian municipal bond market and the high-yield bond market north of the border is extremely narrow.”
As Canadian rates peaked the net effect was that $200 billion of funds poured into fixed-income alternatives that traditionally would have bought high yielding equities.
Still, many of these sectors are confronting idiosyncratic obstacles, de Verteuil noted. “Communications stocks are facing aggressive price competition and regulatory challenges, real estate companies have long-term Covid effects and banks continue to face rising loan losses.”
But with the Bank of Canada kicking off its easing cycle in June, de Verteuil says some funds have started flowing back into high-yielding equities, where performance is improving. The real estate and utilities sectors rose 11% and 7.8% in July respectively, for example. The central bank has now cut interest rates twice and additional cuts are expected in September and October.
As rates come down demand equating to 15% of the market capitalization of the country’s utilities, REITs, telecoms and financial sectors should pick up. “Canadian investors should continue rotating into these sectors in the coming months,” de Verteuil wrote.
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