• Higher interest rates have led many investors to wonder if they should be increasing bond exposure.
• In the past two years, Canadian dividend stocks have become much more interest rate sensitive.
• This can be seen clearly in the increased correlation between these stocks and bond prices.
• Given the higher outright yields and tax benefits, dividend stocks should outperform bonds as interest rates eventually fall.
• The path to lower yields has taken a pause for the time being, but we expect it to resume once central banks move to the next phase which involves actually cutting interest rates.

Turns out bonds aren’t so boring after all…

The past few years have shown investors that the bond market doesn’t have to be boring. Granted, for 2022 and most of 2023 the bond market was exciting for the wrong reasons, but the upshot is that we now have reasonable interest rates available to investors for the first time really since the Great Financial Crisis. This improvement in yields naturally has people asking if we should be adding substantially to bond holdings. As we have said in the past, the opportunity in discounted bonds still remains, especially for investors who currently hold cash and maturing GICs.

…and portfolios are already poised to benefit from a turnaround…

When it comes to changing equity allocation, we have seen an interesting development whereby the dividend-heavy portions of the Canadian equity market have become more correlated with bond prices than they typically have been, especially in the past year. As seen below, the Telecom, Utilities, and Pipeline sectors have all seen their share prices very closely to the price of the 10-year Treasury bond. This means that portfolios already stand to benefit from a turnaround in bond prices without any change to asset allocation.

…with the benefit of a higher and more tax efficient income stream

Because the dividend yields on these sectors tends to outstrip those of bonds, that means investors who exercise patience with these securities will enjoy a higher income stream that is taxed much more favourably given the benefits of the dividend tax credit. As we saw in the final two months of 2023, share price appreciation can happen quickly when the bond market starts to rally. While the path to lower interest rates has taken a pause, we expect to see a renewed path downwards once central banks engage in their long-awaited interest rate cutting cycle.

 

 

The Harbour Group

416-842-2300

Putting you first, every time, to help you navigate the complexities of managing your wealth. All of our team members, all of our resources, all of our collective insight: ALL FOR ONE: YOU™.

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