Banks and Cable/Telcos in the Dividend Sweet Spot

With the S&P/TSX Composite Index up 3.5% on a year-to-date basis, Scotia’s equity strategy team remains in the procyclical camp. Central bank tightening is typically seen as an inflection point between a cyclical and defensive bias. While remaining bullish on equities in the near-term, we highlight that the Canadian equity market is trading within 5% of our strategy team’s target of 14,750 for the S&P/TSX. With this in mind, we think the spotlight will soon refocus on dividend income as an increasing contributor to total returns.

In the Canadian context, we think the sweet spot for dividend income occurs at the confluence of a positive yield spread over government bonds and a dividend growth rate of at least 10%. As presented in exhibit 1 below, there is generally a trade-off between dividend yield and the growth rate of dividends. Defensive sectors tend to have higher yields but lower dividend growth, whereas cyclical sectors typically have lower dividend yields and potentially higher dividend growth rates.

At present, we think financials, particularly Canadian banks, and cable/telco stocks are in or about to enter the dividend sweet spot. After a two year hiatus caused by the financial crisis of 2008-2009, we think dividend growth for the bank group is set to resume. While the five-year compound average dividend growth rate of 7.4% for the bank group is healthy, dividend growth is likely to rebound to the low double-digit range in the coming years.

Above comments courtesy of my Portfolio Advisory Group group - Himalaya Jain