The dean of Canadian dividend stock investing says that one of the market metrics he follows is flashing a warning sign.
Tom Connolly, proprietor of the Connolly Report and the dividendgrowth.ca website, tracks a group of 23 blue chip Canadian companies he believes will provide reliable dividend income. To get $1 in dividend income a year from this select portfolio, investors would now have to buy $24.57 in stock, according to his calculations. At the beginning of last month it was $25.58. Both figures are sharply below the average level of $33.67 since 2000.
Mr. Connolly worries that something is wrong here. At first glance, the numbers suggest quality, dividend-paying stocks are on sale, and getting cheaper.
This trend is perplexing because the prime alternative for low risk investors – super-safe government bonds – are getting more expensive. Prices and yields move in opposite directions, and the higher prices have driven government bond yields to microscopic levels of less than 2 per cent a year for 10-year maturities.
One might think that investors would flock to the seeming bargains among safe dividend stocks, where they could more than double their income compared to buying an equal dollar amount of government bonds. Instead, investors are doing the opposite: They're shifting money from decent-yielding dividend stocks to lower yielding bonds.
Mr. Connolly says the damage is being inflicted in the financial sector, where the shares of companies such as Sun Life Financial Inc. and Great West Lifeco are heading down, which automatically pushes their yields up. Sun Life now yields 6.6 per cent, while Great West is at 5.8 per cent. Banks are being affected too. Canadian Imperial Bank of Commerce, for instance, yields about 5.1 per cent.
Mr. Connolly believes the high yields reflect fears that the world is in a drawn-out financial crisis. If his assessment is correct, the growing cheapness of dividend-paying stocks is actually a warning of an economic storm ahead that will hit particularly hard at the financial services sector.
The same trend hasn't yet affected other dividend sectors. Grocers, such Empire Co. and Loblaw Companies, yield 1.6 per cent and 2.6 per cent respectively. Mr. Connolly figures this is because investors are putting a premium on the relative security of food companies. Everybody has to eat, after all, even if the economy tanks, suggesting investors are more than willing to pay up for dividends from these companies.
Yields are also well behaved among the utilities in his portfolio, such as Fortis Inc. (3.6 per cent yield) and Canadian Utilities (2.7 per cent yield). People continue to use electricity come rain or shine, so investors are happy to accept relatively low, very safe yields.
Mr. Connolly likes BCE (5.2 per cent yield), and while he acknowledges the stock could lose ground in a market rout, "it's hard to beat 5 per cent with some dividend growth" as a possibility. But he says many of the investors who follow his market letter have already loaded up on the telecom giant. "People say to me: 'Well, okay, Tom, we've got enough BCE. What do we buy next?'"
The question of what to purchase next makes Mr. Connolly uneasy. His big worry is that stocks may be in a long-term bear market.
An array of negatives hang over the economic outlook. The world is awash in debt, the Chinese economy is slowing, and even gold, the traditional haven, has been weak.
Mr. Connolly worries that things could get so bad that the lows of the 2009 bear market could be retested. But if that happens, there would be a silver lining. Back in 2009, investors could have bought $1 worth of dividends for the rock bottom price of $16.46 worth of stock, providing a great entry point for dividend stock investing.