Falling interest rates to bring flood of funds back to financials, REITs, utilities and telecoms
Change is in the air in Canada’s investment landscape, according to the Canadian Imperial Bank of Commerce.
The quick rise in interest rates over the past few years drove many investors into term deposits and other short-term fixed income products. CIBC estimates over $200 billion went to these products that normally might have bought high-yielding equities.
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“With falling rates, it makes intuitive sense that some of this will reverse – but also reasonable to ask “when” will this occur?,” said CIBC analysts led by Ian de Verteuil in a research note.
To answer that question the CIBC team looked back at funds flow of Canadian bank term deposits over the past 35 years. There have been four periods of “meaningful” term-deposit outflows and on average they occurred 350-400 days after the peak in the 3-month bill and 2-year bond rates in Canada.
“Interestingly, these two rates actually peaked in October 2023 and have been falling since,” they said.
So where will the money go?
CIBC believes 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 2-year government rates is also becoming increasingly attractive, they said.
“Sectors such as REITs, Utilities, Telecoms and Financials have added appeal of better-than-average business and earnings stability,” said the analysts.
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CIBC expects the Bank of Canada‘s overnight target rate to fall to 3.75 per cent by the end of this year and 2.5 per cent by the end of 2025.
If its forecast bears out, the decline in rates at this pace should drive investors back to Canadian dividend paying stocks, especially since many of these equities have performed poorly compared to the boarder market over the past few years.
“If interest rates fall as we expect, what was a material headwind should turn by 180 degrees and provide support for REITs, Utilities, Telecoms and Financials. We expect these sectors to outperform in the coming quarters,” said the analysts.
But money flow is not enough; business performance also matters.
Telecoms face the challenges of more competition and changing regulations and some Real Estate Investment Trusts are still suffering from the impact of the COVID-19 pandemic and hybrid work, said the analysts. Utilities have to contend with a shift in power generation.
“Financials are likely to be the biggest winners,” said de Verteuil’s team.
Bank earnings out last week show the strength of the domestic personal and commercial banking business, and life insurers are managing the changing rate environment.
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“As such, we expect most flow into these traditional outperformers,” the analysts said.
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The Bank of Canada surprised no one Wednesday when it cut its benchmark interest rate for the third time in row.
The 25-basis-point cut was widely expected but some still thought the central bank should have gone further.
“It’s said that victory goes to the bold, but the Bank of Canada went with the more cautious approach of yet another quarter point rate cut,” said Avery Shenfeld, chief economist at CIBC Capital Markets, after the decision.
“That left rates still well above where they will have to head to get the economy and labour markets into better shape.”
Something to know — aside from the pandemic, the last time the central bank cut its rate three times in a row was in 2009 at the height of the global financial crisis.
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Are you worried about having enough for retirement? Do you need to adjust your portfolio? Are you wondering how to make ends meet? Drop us a line with your contact info and the gist of your problem and we’ll try to find some experts to help you out, while writing a Family Finance story about it (we’ll keep your name out of it, of course). If you have a simpler question, the crack team at FP Answers, led by Julie Cazzin, can give it a shot.
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Want to learn more about mortgages? Mortgage strategist Robert McLister’s Financial Post column can help navigate the complex sector, from the latest trends to financing opportunities you won’t want to miss. Plus check his mortgage rate page for Canada’s lowest national mortgage rates, updated daily.
Today’s Posthaste was written by Pamela Heaven, with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.
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