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Why the rate-cut bounce in TSX dividend stocks may not last

A forklift is driven past wood posts at Interfor's Acorn Division mill in Delta, B.C., on Friday September 14, 2012. Bruce Campbell, president and portfolio manager of StoneCastle Investment Management, is seeing benefits from companies they own with U.S. sales, such as Interfor, which has jumped about 15 per cent since the rate cut was announced on Wednesday. Other forestry stocks have also surged.

DARRYL DYCK/The Globe and Mail

Investors who've been on the fence about whether to sell equities affected by rising interest rates are being rewarded for their patience – or procrastination – after last week's surprise cut from the Bank of Canada.

Investments in sectors such as real estate investment trusts, telecommunications and utilities saw a boost from the bank's decision on Wednesday to cut the benchmark rate due to the impact of falling oil prices on the Canadian economy. Investments in high-yield, capital-intensive sectors often suffer when rates rise because the cost of borrowing for these companies increases, which can affect cash flow. Investors also tend to turn to less risky yield plays such as government bonds.

The resulting drop in the Canadian dollar also benefited manufacturing and other companies with a strong U.S. sales presence.

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Investors stand to make more money from many stocks in these sectors with the rate-hike tension off the table, analysts and money managers say, especially if rates fall further as some now predict.

Others are more cautious, however, saying valuations are getting expensive in the high-yield, interest-rate sensitive sectors.

"The interest-sensitive play is running out of steam," says Jon Palfrey, senior vice-president and portfolio manager at Leith Wheeler.

"They've had a nice tailwind, but their prices are getting rich."

According to S&P Capital IQ, Canada's utilities sector is trading at about 22 times forward earnings, while telecoms and REITs are trading about 17 times, in line with the overall S&P/TSX composite index. By comparison, banks are trading at 11 times forward earnings.

The REIT, utility and telecom sectors have had a good run over the past year, outperforming the broader S&P/TSX composite index.

They started off weaker at this time last year, amid talk of rising interest rates. However, prices and valuations for the sectors crept up as bond yields started to fall without interest-rate action, before getting a lift after the news last week.

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Mr. Palfrey says his firm is more interested in sectors seen as under pressure in a low-rate environment, such as banks, as a longer-term value play.

"They're cheap because there is concern about their outlook," Mr. Palfrey said of the banks, which includes the impact of lower rates on margins and the ability for consumers to pay off growing debt they're expected to take on with lower rates. "Once interest rates move up off of these historic lows … they'll make more on their interest-rate spread."

John Stephenson, a portfolio manager at Stephenson & Co. Capital Management, sees the banks as a "sideways bet" for investors in the coming months because of the pressure lower rates will put on its profits.

He believes many REITs, telecoms and utilities will do well, but his firm is more interested in the Canadian-dollar impact of lower rates on sectors such as industrials, including auto part makers such as Magna International Inc. and Linamar Corp. or aviation manufacturer CAE Inc.

"Anything that is manufacturing here in Canada will do well," said Mr. Stephenson, who is also heavily invested in the U.S. market right now.

While materials should do well, lower commodity prices will continue to weigh on mining and oil and gas stocks, he said.

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Bruce Campbell, president and portfolio manager of StoneCastle Investment Management, is seeing benefits from companies they own with U.S. sales, such as Interfor Corp., which has jumped about 15 per cent since the rate cut was announced on Wednesday. Other forestry stocks have also surged.

Mr. Campbell's firm also owns shares of Air Canada, which dropped after the rate cut because of its large U.S.-debt exposure. That follows a recent rally by the airline's stock on lower fuel prices amid oil's slump.

Regardless of the recent market gyrations, Mr. Campbell said his firm isn't changing its overall investment strategy as a result of the interest rate cut.

"I don't think you should really be making investment decision based on [the central bank's rate cut]," he said.

"Just as they surprised this way they can do it the other way."

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About the Author

Brenda Bouw is a freelance writer and editor based in Vancouver. She has more than 20 years of experience as a business reporter, including at The Globe and Mail, The Canadian Press, the Financial Post and was executive producer at BNN (formerly ROBTv). Brenda was also part of the Globe and Mail reporting team that won the 2010 National Newspaper Award for business journalism. More


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