To my clients:

It was a down week for North American stock markets with the Canadian TSX finishing down 1.2%; the U.S. Dow Jones Index finishing down 1.3%; and the U.S. S&P 500 finishing down 0.7%.

Well, September pretty much lived up to its reputation as being a traditionally poor month for the markets. Depending upon the index, markets were down ~ 3 to 4%. That’s the bad news. The good news is that markets remain up nicely for the year and were due for a correction after a strong first 8 months. I’d expect the up-trend to reassert through year-end. YTD, discretionary clients are participating in equity upside roughly in line with equity market returns (in fact, slightly better on the U.S. side when compared to the S&P 500).

I’m going to make a slight pivot this week and note that a handful of discretionary clients have a more dividend centric Investment Policy in place, and further that an influx of non-discretionary clients (from another advisor) over the past 18 months are also following a dividend centric approach. Owing to the predominance of dividend paying stocks in these portfolios, these mandates have underperformed the experience of the discretionary models I have in place for the majority of my clients. I bring this up because I have been receiving queries from these clients the past month or so and I suspect where a few are asking, many more are wondering. So let’s address the topic…

Many consider higher dividend paying stocks of quality companies to be the “Steady Eddies” of the equity world. In large part, I’d agree. The requirement to pay meaningful and consistent dividends enforces a discipline on the part of management of these companies since cash flow must always be on hand to pay the required dividend obligations. And in a low-rate world as was in place from the turn of the century more than 20 years ago until the recent rate hiking cycle began at the beginning of 2022, these dividend paying stocks (typically 3 to 5% annual dividends, sometimes more) were a very attractive alternative to GICs and bonds that were often paying less than 2%. Further, dividends of such companies tend to grow from year to year, often by as much as 5 to 10% per year (i.e. a 3% dividend become 3.15% to 3.30% the subsequent year). As such, I like dividend-paying stocks. In fact, my broader discretionary portfolios are littered with such companies (mostly on the Canadian side of portfolios).

BUT, when rates rise – as they have the past 20 months, the higher bond and GIC rates make the “high” dividends of such companies less attractive. Many risk-averse investors wonder “why would I tolerate the ups and downs of the market when I can get over 5% in a GIC?” I sympathize with this perspective and it lies at the heart of why I decided to add some stability to discretionary portfolios by increasing the fixed-income allocation last week. Yet, for most clients, I wouldn’t recommend going too far down this path. For those who recognize there will be accompanying volatility in the value of their portfolios, I reassert what I commonly tell clients: a high quality equity (i.e. stock) portfolio WILL produce the best long-term results for clients. But again, there will be indigestion inducing volatility along the way.

So, returning to dividend-paying stocks, because rates have risen these stocks have underperformed. But this dynamic is not likely to persist. In fact, rate futures are anticipating rate cuts in 2024. When interest rates decline, then dividend paying stocks become incrementally more attractive once again. That said, I’d be surprised if we return to the era of near zero rates we had for the better part of two decades. As such, while a tailwind looms for dividend paying stocks when interest rates are cut, I’d not expect it to be as strong or as sustained as it was from 2008 through 2022 (especially), or to a lesser extent from 2000 to 2007.

Bottom line: dividend-paying stocks are likely to recover and return to being the Steady Eddies of those portfolios concentrated in such stocks. If you rely upon the dividends for income, I see no reason to radically shift course. But I’d temper any expectation that these stocks will return to the heyday performance of the prior decade. It is for this reason why I supplement my broader discretionary portfolios with high quality growth stocks. A balance between growth and dividend-payers is likely to perform better through a wider range of market environments than a stylistic approach rooted in only dividends or only growth.

That’s it for this week. All the best,

Nick

Nick Scholte, CIM, FCSI

Senior Portfolio Manager

Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
3200-1055 West Georgia │ Vancouver, BC │ V6E 3P3
Toll Free: 1.844.665.9900 │Email: nick.scholte@rbc.com

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