In an August research note, Ian de Verteuil, an analyst from CIBC, discussed the potential shift in Canadian investment preferences due to falling interest rates. De Verteuil’s team predicts that if the downward trend in rates continues, Canadian investors might redirect approximately $220 billion (US$161 billion) into dividend-paying stocks, moving away from fixed-income products. This prediction follows a period of rapidly rising interest rates that had previously funneled over $200 billion into short-term fixed-income products like term deposits, which would traditionally have been invested in high-yielding equities.
“Canadian investors have always struggled to find yield,” de Verteuil wrote. “Unlike the US, there are very few options for ‘high’ nominal yield—there is no Canadian municipal bond market, and the high-yield bond market north of the border is extremely narrow.”
The Tuesday data showing that Canada’s annual inflation rate reached the central bank’s 2% target in August has fueled expectations of a 50bps cut by the Bank of Canada in October. This follows a 50bps rate cut by the Fed, signaling the beginning of an easing cycle and providing room for more flexible monetary policy in Canada. CIBC forecasts a reduction in the Bank of Canada’s overnight target rate to 3.50% by the end of this year and to 2.25% by the end of 2025.
“With falling rates, it makes intuitive sense that some of this will reverse – but also reasonable to ask “when” will this occur?” CIBC analysts led by de Verteuil said in a research note.
CIBC analysts have examined the historical flow of funds in Canadian bank term deposits over the past 35 years, identifying four periods of significant outflows, typically occurring 350-400 days after the peak in three-month bills and two-year bond rates. Notably, these rates peaked in October 2023 and have been declining since.
CIBC believes that high-dividend-paying Canadian stocks are a ‘natural’ home for these funds as they offer tax advantages over interest income, and dividends can grow over time. The relative yield of these stocks compared with two-year government rates is also becoming increasingly attractive, they said.
However, the analysts caution that while capital inflows are critical, the fundamental performance of businesses should not be overlooked. They stress that a high dividend yield does not automatically equate to a sound investment, especially if a company’s profits are on a downtrend. Investment returns are intricately linked to a company’s EPS growth and its shareholder returns.
For investors looking for sustainable returns, it is advisable to select companies that demonstrate a balance between EPS growth and dividend growth. Here are the top ten companies with the highest EPS compound growth rates over five years among those with a dividend compound growth rate greater than 5%, according to Bloomberg. These stocks are primarily in the energy, retail, and financial sectors. Notably, $Cenovus Energy Inc (CVE.CA)$ has achieved a 124% dividend compound growth rate alongside a 60% EPS compound growth rate over five years.”