Investors have been getting a bit of a free ride from low volatility Canadian stocks in the post-financial crisis era, frequently generating index-beating returns and strong dividend income from the most predictable and reliable companies on the market. The good times for these investors, however, may be over according to CIBC managing director of global market research Ian de Verteuil.
Mr. de Verteuil defines low volatility stocks as those with low six- and 12-month price variability, low beta (degree of sensitivity to movement in the benchmark) and where analysts agree most on earnings growth forecasts. Financials, utilities, consumer staples and industrials currently account for 70 per cent of the low volatility basket.
The analyst states bluntly that “low vol is unlikely to outperform in the long term.” There are two main hurdles for low volatility stocks - higher for longer interest rates and commodity prices.
In the first instance, low volatility stocks in the telecommunications and utilities sectors have been adversely affected by higher long-term interest rates. The yield on the S&P/TSX Utilities Index, for example, currently 4.8 per cent, looked a lot more attractive when the risk-free yield on the government of Canada 10-year bond was below 2 per cent after the financial crisis. Now, however, the 10-year yield is more competitive at 3.65 per cent.
In the case of commodities, energy producers and miners (particularly in the precious metals subsector) are subject to capricious commodity prices, which means they rarely qualify as low volatility stocks.
In recent months, a market supported by bullion, copper and crude price strength has left low volatility sectors underperforming badly. The lowest volatility stocks (first quintile) fell 11.4 per cent in March and another 7.9 per cent in April.
Interest rates and bond yields fell in more or less a straight line from 1990 to mid-2020 when they had little or no room to fall further. Every move lower was good for the equity market and particularly for low-but-stable profit growth companies paying a dividend.
Higher-for-longer rates will hurt low volatility, dividend paying companies. For as long as that trend lasts, the free lunch for conservative investors will be over.
-- Scott Barlow, Globe and Mail market strategist
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What’s up in the days ahead
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Compiled by Globe Investor Staff