It’s déjà vuall over again. About two years ago, interest-sensitive securities were battered after comments by Ben Bernanke, then chair of the U.S. Federal Reserve Board, that the Fed would soon start tapering off its quantitative easing program. The “taper tantrum,” as it came to be known, rocked the markets. Interest-sensitive securities plunged in price as bonds, preferred shares, REITs, utilities, and telecoms were hit. In case you haven’t noticed, we’re seeing a similar phenomenon now, albeit in a more muted form.
Once again, the culprit is the Fed, which appears to be set on embarking on its first tightening cycle since the crash of 2008 forced it to cut interest rates to near zero. As matters stand now, it looks like the first rate hike will come perhaps as early as the Fed’s next rate decision on Sept. 17.
Rate-sensitive securities hit
But, as usual, the markets aren’t waiting for a formal announcement. The retreat in the prices of interest-sensitive securities is well under way. Interestingly, it is hitting Canadian stocks hardest, even though the Bank of Canada is much farther away from raising rates than the Fed is. That’s because the Fed influences securities yields more than our own central bank.
The REIT sector has suffered the most damage so far. From the end of April to the end of August, the S&P/TSX Capped REIT Index fell 12.7%. REITs had been performing well prior to that but the ongoing rate uncertainty has wiped out all the year to date gains in the sector. As of the close on Aug. 31, the S&P/TSX Capped REIT Index was showing a year-to-date loss of 6.2%.
Every REIT in the sub-index shows a similar chart pattern, with a downward movement through the summer. SmartREIT (TSX: SRU.UN), formerly Calloway REIT, and H&R REIT (TSX: HR.UN), two of the stronger entries through the summer, are now well down from their 52-week highs.
Utilities stocks as a group are down 5.6% year to date as of the end of August. However, a couple bucked the trend, including Northland Power Inc. (TSX: NPI),up 7.4% year to date, and Emera Inc. (TSX: EMA), up 13%.
Preferred shares have also suffered, although not as badly as utilities. That sub-index was down 3.0% year to date to the end of August.
Although REITs, utilities, and preferreds are the most high profile of the interest-sensitive securities on the TSX, all dividend-paying stocks are vulnerable. A look at the S&P/TSX Composite High Dividend Index shows how the pain is being spread across the board. It is composed of 75 dividend stocks from all sectors, with the heaviest weightings in energy and financials. That sub-index was down 12% year to date to Aug. 31.
We’re seeing a similar story on Wall Street. The Dow Jones U.S. Real Estate Index has lost 8.3% for the year to date as of the end of August. The Dow Jones Utility Index has dropped 10%.
Don’t rush to buy on weakness
We are likely to see more of this pain as the hour for the Fed rate hike approaches. That will mean more capital losses on interest-sensitive securities you own. The flip side is that dividend yields will rise as share prices fall, making the cash flow from income stocks more attractive. But don’t rush to buy. Once the Fed starts hiking rates, it will probably continue to do so for some time. That will drive the prices of these securities even lower.
Of course, you can decide to dump all the interest-sensitive stocks out of your portfolio and wait. But the tightening cycle could continue for a few years, during which time you’d lose all the dividends. Moreover, the selloff may have been front-end loaded. Future market reaction and price declines may be more modest.
On balance, my advice is to continue holding any good-quality interest-sensitive stocks in your portfolio, but don’t add more at this stage. Wait for the bargains to emerge.
Courtesy Fundata Canada Inc. © 2015.Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder andThe Income Investor newsletters, available through his Building Wealth website. This article is not intended as personalized advice.
