The Brightest Spots in the Market

10/10/2011 10:45 am EST


Rob Carrick

Columnist, The Globe and Mail

Defensive sectors, REITs, and preferred shares have all performed solidly…unlike in 2008, when there was nowhere to hide, writes Rob Carrick, reporter and columnist for The Globe and Mail.

Bad news: The stock market is having a terrible year.

Good news: It’s an old-fashioned terrible year.

Remember 2008? That was a new kind of bad. Other than government bonds, pretty much nothing else worked. Defensive stocks were offensively bad, REITs were the wrong place to be, and preferred shares were anything but.

In 2011, defensive sectors like telecommunications and consumer staples have held up well as the S&P/TSX composite slid. Real estate investment trusts have been a tower of strength, and preferred shares have been solid as well. It may be a bad year for the stock market, but not for all stocks.

"In 2008, there was widespread fear that the global financial system was breaking down," said James Hymas, president of Hymas Investment Management and an expert on preferred shares. As much as there’s reason to worry about a global economic slowdown and the debt problems of some countries, "we’re very definitely not in the state of panic we were three years ago."

In the stock market, this means that not everything is a downer right now. It’s easy to overlook this as the broad market indexes keep pushing ever lower.

The problem with using the S&P/TSX composite index to gauge the Canadian stock market is that it’s almost 48% weighted to two of the sectors hit hardest, energy and materials (that’s mainly mining companies).

Three of the strongest sectors lately have been telecom, accounting for just under 5% of the index; consumer staples, at 2.7%; and health care, at a whopping 1.1%.

Now you see why the stocks that keep falling have a lot more influence over the index than the stocks that are holding their ground or even rising.

What works in today’s investing environment? "Businesses that have shown an ability to deliver in good markets and bad markets," said Patrick Reddy, Canadian equity analyst at Leith Wheeler Investment Counsel. "It’s companies that do not have a volatile earnings stream and have a dividend that is safe, and growing."

Among the best performing stocks of the year are such dividend-payers as Tim Hortons (Toronto: THI), Enbridge (Toronto: ENB), Telus (Toronto: T), and Canadian Utilities (Toronto: CU).

Another dividend stock that’s up on the year is TransCanada Corp. (Toronto: TRP), which is a top holding in Leith Wheeler’s new Canadian Dividend Fund. This fund has been a top performer among Canadian equity funds for the year through October 6, with a loss of 3.3%. The S&P/TSX composite index was down 12.4% over the same period.

Another stock in the Leith Wheeler Canadian Dividend Fund that’s delivering right now is Saputo Inc., (Toronto: SAP), a big player in cheese and other dairy products.

Saputo is in the consumer staples sector, which is considered to be among the most defensive of sectors. Seven of the 12 stocks in the S&P/TSX capped consumer staples index were up for the year through October 6, and all but two of the stocks in the red were down by 7.7% or less.

The sector with the best defensive performance for the year through October 6 was telecom services, where all stocks were up for the year, and the dividend yields range from a low of about 4% for Rogers Communications (Toronto: RCI.B) to a high of 7.1% for Bell Aliant (Toronto: BA).

BCE Inc. (BCE), yielding about 5.4%, has risen about 9% this year. That’s a huge reversal from 2008, when the stock was kicked around by investors who were disappointed about the failure of a deal in which the company was to be taken private at $42.75 a share. BCE shares now trade around $38.

Health care, a classic defensive sector, was another top performer in the Canadian market. There’s not much meat here for investors, though. There are only four stocks in the S&P/TSX capped health care index—CML HealthCare (Toronto: CLC) and Nordion Inc. (Toronto: NDN) have fallen in 2011, but not as much as SXC Health Solutions (Toronto: SXC) and Valeant Pharmaceuticals (Toronto: VRX) have risen.

REITs are another example of a high-yielding sector that has defied the market gloom.

"The ability to buy something that throws off a 7-, 8- or 9% yield where you get paid on a monthly basis is really attractive to people," said Dennis Mitchell, manager of the Sentry REIT Fund and deputy chief investment officer at Sentry Investments. "The No. 1 reason you buy REITs is their tax-efficient yields."

The tax efficiency of REITs comes through the return-of-capital component in their monthly distributions. A return of capital payment isn’t taxable now in a non-registered account, but it has the effect of increasing your potential capital gain when you sell in the future.

A caveat if you’re buying REITs now is that they tend to underperform when the economy is weak. Many REITs are essentially mall, office, and industrial park landlords, and they’re vulnerable to tenants going bankrupt or moving to smaller quarters.

High yields are also a factor in the strength of the preferred share market lately. The dividend yield on the S&P/TSX preferred share index as of late this week was 5.3%.

Hymas, the preferred share specialist, said that’s substantially more than you can get from corporate bonds, which themselves are a step up in yield from government bonds. "There’s a great number of investors whose portfolio could use a few preferreds in them," Hymas said.

The big difference in the preferred share market between today and 2008? Hymas said it’s that investors aren’t questioning the stability of the banking system this time around. The preferred share market in Canada is 80% exposed to banks and insurance companies, all of which were treated as toxic in the 2008 crash.

Utility stocks have been strong this year, too, but Leith Wheeler’s Reddy is unenthusiastic about them because he feels they’re no bargain at current prices.

"I think a lot of them will have a tough time growing their dividends over time," he said. "We’d rather put money in businesses that have better valuations and greater propensity to increase their dividends."

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