Safety has rarely been so expensive in the stock market. Which has to make you wonder if supposedly safe stocks are now all that safe after all.
Canadian bank stocks offer a case in point. As Jason Kirby pointed out this week, this country’s dominant financial institutions are suddenly trading at historically lavish price-to-earnings (P/E) multiples. For much of the past two decades, their shares fetched somewhere between 10 and 12 times earnings. Now they are changing hands at P/E ratios of 14 to 18 times.
This does not make a lot of obvious sense. A company’s P/E multiple typically shoots up if its growth outlook suddenly brightens or if its risk plummets. Neither holds true here.
Indeed, you can argue that Canada’s big banks should be trading at lower, not higher multiples, given what is happening in their key domestic market. Canada’s population has declined in recent quarters. Home prices are slipping. Meanwhile, U.S. President Donald Trump is waging a trade war against what he loves to call the 51st state. All those factors would seem to be negatives for Canada’s big lenders.
Trade limbo is quietly taking a heavy economic toll
So what is driving bank shares into the stratosphere? The simplest explanation is that investors are looking for safety in a market gone mad.
Think about it: At a time when SpaceX SPCX-Q (or, more properly, Space Exploration Technologies Corp.) can launch the biggest initial public offering in history without a penny in profits, and when U.S. tech giants are betting trillions of dollars on a highly uncertain competition to develop artificial intelligence, there is something undeniably comforting about sidestepping the AI wars and loading up on non-tech businesses that have a long record of profitability and steady payouts.
Investors’ sudden turn toward Canadian bank shares is part of a larger stampede toward such companies. The pipeline operator TC Energy Corp., the grocer Loblaw Companies Ltd. L-T, and the electricity generator Canadian Utilities Inc. CU-T are all trading at their highest multiples of earnings in years. Investors may be betting that tried-and-true stalwarts like these won’t be disrupted by AI.
Dividends are a powerful additional lure. Rates on guaranteed investment certificates (GICs) have shrunk in recent years, so people have had to search for new ways to generate reliable income. Companies in steady industries, with reliable payouts, have therefore enjoyed an unusual surge in popularity.
For dividend investors, this has meant some spectacular returns. One example is Vanguard Canada’s Canadian High Dividend Yield ETF VDY-T. It has rocketed ahead by more than 50 per cent over the past year – a striking result for a collection of relatively slow-growing banks, pipelines and energy producers.
At this point, though, investors may want to take a beat before diving into the dividend frenzy. Reaching for safety and reliable payouts is eminently sensible in a rambunctious market. But, at current prices for purportedly sensible stocks, the quest for sanity is verging on its own form of madness.
It would not take much to knock these supposed havens for a loop. In fact, it would require only a reversion to more typical multiples. If Canadian banks or grocers or pipelines were to go back to trading at the valuations that held sway for much of the past two decades, they would lose 20 per cent or more of their current value.
If nothing else, investors should ponder what they’re getting at current prices. The flip side of the big gains in dividend stocks is smaller yields. This is just math. Dividends don’t shrink in absolute terms – they actually grow in most cases – but they become smaller in comparison with suddenly enlarged share prices. This lowers yields and makes dividend stocks less attractive in comparison to GICs and bonds.
Royal Bank of Canada RY-T was yielding more than 4 per cent a couple of years ago; now it yields 2.4 per cent. Canadian Utilities was paying more than 5 per cent in early 2025; now it’s 3.3 per cent. Similarly, TC Energy’s yield has been cut in half since 2024, sliding from more than 7 per cent to about 3.6 per cent now.
At these levels, investors are getting bond-like payouts with equity-like volatility. That is not a great combination. Dividend stocks will always have their attractions, and there is nothing wrong with holding them if you’re aware of the risks, but tumbling yields mean that future returns are unlikely to match the lush results of the past couple of years.
So where can investors look for a better deal? Opinions will differ, but I’m intrigued by some of the stocks battered in the recent software selloff. In Canada, Constellation Software Inc. CSU-T is down by nearly 45 per cent from its highs of a year ago. In the United States, IBM Corp. IBM-N is off nearly 20 per cent this month. If you believe that AI won’t be quite as disruptive as many fear, stocks such as this represent tempting value.