This edition of Market Factors begins with dividend stocks and when to buy them in a volatile rate environment. Section two covers a major surprise regarding inflation and bond yields. The diversion makes me a wuss and we close with quick hits as always
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Income investing
Dividend stock buying guide
Scotiabank strategist Hugo Ste-Marie views domestic investors as poised to pile into REITs, pipelines, telecommunications and utilities investments - the most interest-rate sensitive sectors - on the exact second that bond yields level off. Mr. Ste-Marie believes they should wait.
The hot U.S. inflation data released Wednesday highlight the risks of buying rate-sensitive market sectors in the current environment. Remember that rate-sensitive sectors’ performance is inversely correlated to bond yields - they fall when yields rise.
Today’s data pushed the U.S. 10-year bond yield sharply higher, and made the yields from interest rate-sensitive stocks less attractive. The U.S. 10-year bond is all-important, as Canadian REITs, pipelines, utilities and telecommunications stocks are more sensitive to this yield than the government of Canada 10-year yield. The only exception among rate-sensitive sectors within the TSX is consumer staples stocks, which are more correlated to the domestic bond market.
The U.S. 10-year yield has stalled out repeatedly at the 5.35 per cent level, leading some investors to conclude that this is a resistance level that might represent the cycle high for interest rates. This implies that interest rate sensitive equity sectors are now close to their lows and set to rally as rates and bond yields begin to fall.
Mr. Ste-Marie does not believe now is a buying opportunity for REITs, pipelines, utilities and telecommunications. He believes that two conditions must be met before these sectors are attractive.
The first condition is a sustained decline in bond yields. He notes that the 10-year U.S. Treasury yield jumped more than 80 basis points during the third quarter and is likely to stabilize near current levels. He does not foresee conditions that will put yields materially and durably lower.
The second condition that must be met is a deterioration in the U.S. economic growth outlook. Mr. Ste-Marie sees no cracks in the U.S. economy at the moment and is following the Citi U.S. economic surprise index for indicators of future growth.
Domestic dividend stocks will continue to pay out and support income investors in almost all cases. The stock and unit prices, however, may be set for volatility in the weeks ahead until U.S. bond yields begin to trend lower.
Economics
Inflation surprise
Here’s a surprising fact from BMO chief economist Doug Porter: inflation isn’t causing higher yields. In the most recent edition of BMO’s weekly Focus report, Mr. Porter noted that the recent jump in bond yields was almost entirely the result of real yields climbing – the bond yield after inflation is subtracted.
The economist further noted that inflation pressures in advanced countries declined in August – from 2.7 per cent to 2.4 per cent. This is despite higher oil prices.
Mr. Porter concludes, “even with all the chatter about rising inflation and the hiking response of most central banks, the reality is that this year’s inflation story has been about energy and almost nothing else.”
Torsten Slok from Apollo Global Management added to the discussion with an argument that expectations of rising real rates are responsible for the bond yield increase. Investors are also demanding more term premium, the additional yield that compensates bond holders for holding longer term issues.
Summer H. Howell as Carrie, from Prime Video, a TV series based on the Stephen King bookRobert Falconer/Supplied
Diversions
Diversions headline
The Make Use Of site presented their favourites among available Stephen King-derived movies for the Halloween season. I will not be participating in any way.
The success of Amazon Prime’s Carrie miniseries is the catalyst for the list, which features some great actors and stories. Misery, with James Caan, Kathy Bates and human hobbling starts things off. The Shining with Jack Nicholson and a browbeaten (mostly by director Stanley Kubrick) Shelley Duvall is next.
Gerald’s Game is on Netflix. I’ve never heard of this one but it involves a woman who wakes up tied to a bed. The Boogeyman, available on Netflix, is another new one to me. The terrifying murderous clown at the centre of It is also available for streaming.
My brain has trouble distinguishing between real life and what’s on a screen so horror’s a no-go zone. I blame a made for TV movie called Trilogy of Terror that I saw too young. I bet it looks like a high school play if I saw it again, but the damage is already done – I still have dreams about those nasty little bastards crawling out of the fireplace.
My mild disability did not extend to reading horror. I read all the Stephen King in my teens – I remember Pet Sematary being particularly petrifying - along with Dean Koontz, Clive Barker and Peter Straub. Horror movie fans, however, remain inexplicable to me but I wish them well during their favourite viewing season.
The essentials
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Globe Investor highlights
The age of easy money is fading. Tim Shufelt argues that investors aren’t ready for what’s next
Andrew Galbraith on the growing risks of Canadian single-stock ETFs as many more come to market
David Berman points out that Emera’s merger deal is facing a significant headwind from the bond market
Tom Bradley provides five rules for investors drowning in AI news
Quick hits
Macquarie economist David Doyle reassured clients that the Canadian jobs numbers, a loss of 68,000, were not as bad as they looked. Public sector employment contracted by 70,000 and youth employment saw a seasonal 48,000 drop. Full-time employment actually climbed for the 25 to 54 age group.
Most strategists – Morgan Stanley’s Michael Wilson and ISI Evercore’s Julian Emanuel are two examples – expect strong earning growth to protect the S&P 500 from an extended downturn. Wells Fargo’s Ohsung Kwon is more bearish, noting that stocks and bonds are rarely positively correlated when the 10-year Treasury is above 5.25 per cent. The equity-risk premium – the extent to which the equity earnings yield needs to exceed the bond yield before investors add to the former – is near cycle lows and unlikely to compress further. Mr. Kwon believes we are near or past peak U.S. earnings growth and liquidity is declining – a poor combination for equities. He likes health care stocks, where profit growth is improving, to protect against volatility.
Software stocks, not semiconductors, have led the S&P 500 list of top performers for the past 30 days (as of Friday’s close). AI infrastructure software company Everpure Inc. (P-N) led the way with a 49 per cent return and logistics software provider PTC Inc. (PTC-Q) was close behind at 48 per cent. Data centre monitoring specialist Datadog (DDOG-Q) was up 30 per cent while cybersecurity software developers Crowdstrike (CRWD-Q), Fortinet (FTNT-Q) and Palo Alto Networks (PANW-Q) were also among the top ten performers - up 27, 24, and 22 per cent, respectively.
Read this week’s earnings and economic calendar here