Sometimes investors worry about having too much of a good thing. Consider this question from a reader:
“With the current economic situation appearing to be in decline, I am considering taking some profits,” he wrote. “I have a varied portfolio, but it is more weighted to dividend stocks (utilities, telecoms, banks). With the exception of the banks, these have had a pretty good run and are now quite pricey. Given that they are what I consider defensive stocks, would you advocate taking profits in these securities?”
The question is very timely as this has been an extraordinary year for low-risk, dividend-paying stocks. The main reason is the sudden turnaround in interest rates. A year ago at this time, it was generally expected that we were in a new tightening cycle. After a decade of record low rates, central banks, led by the U.S. Federal Reserve Board, were expected to implement a series of increases to push them to more “normal” levels.
Defensive stocks, which are highly interest sensitive, reacted accordingly. Prices pulled back and dividend yields rose as investors demanded better returns for owning riskier stocks as opposed to buying safer bonds.
Then the whole investing world turned upside down. Faced with a slowing global economy, an escalating U.S.-China trade war, and incessant badgering from U.S. President Donald Trump, the Fed reversed course. It first stopped raising rates, then cut them by a quarter point in July and by the same amount in September. There is speculation we could see yet another cut at the next meeting on Oct. 29-30.
The reversal of interest rate fortunes had a manic effect on interest-sensitive stocks. Utilities, which have traditionally been market plodders, staged a huge rally. As of the time of writing, the S&P/TSX Capped Utilities Index was showing a year-to-date gain of 28.9 per cent. If that’s not unprecedented, it’s close to it.
A stodgy stock like Fortis Inc., a Newfoundland-based electricity and gas distributor, finished 2018 at $45.51. It hit a high of $56.94 at the beginning of October, a gain of 25 per cent for the year, before pulling back a little.
Alberta-based Canadian Utilities gained more than 27 per cent from its 2018 close of $31.32 to its recent high of $39.90.
Almost every stock in the utilities sector has posted similar numbers.
Real estate investment trusts (REITs) are another sector that has benefited from falling interest rates. As I write, the S&P/TSX Capped REIT Index is ahead 19.5 per cent year to date. The telecom sector is up 9.5 per cent for the year.
So, to go back to our reader’s question, what now? Should we consider taking profits, or just hang in? There are already signs that the strong rally is over, as investors seem to have priced in future rate cuts. The REIT index is flat over the past month while the Utilities index is down slightly.
Before you make any buy-sell decisions, take a moment to consider why you bought these securities in the first place.
For most people, cash flow and stability would probably top the list. These are what brokers used to call “widows and orphans” stocks. They provide regular income with a minimum of risk. That doesn’t mean the shares would never fall in value. But when they do, it will usually be less than the broad market and the dividends will continue to flow, uninterrupted.
If that’s what you were looking for when you bought these stocks, don’t sell. The share price will rise and fall through market cycles, but these are solid companies that are not going to go bankrupt and leave you penniless.
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Of course, it you’re a trader who bought defensive stocks with the idea of making a quick profit, then take your money off the table and look elsewhere. But hardly anyone buys REITs, utilities, or telecoms with that in mind. This is boring territory.
But if steady income and minimal risk is what you want, boring is great. The extraordinary performance we’ve seen this year is just a bonus.