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By John Heinzl
The Globe And Mail
Report on Business Weekend
Saturday, May 01, 2004
Interest-sensitive stocks are buckling as central banks signal low rates are ending. JOHN HEINZL explores the alternatives
Adrian Mastracci, investment counsel at Vancouver based ‘fee-only’ KCM Wealth Management, says, "We're looking at interest rates going up sooner rather than later. This is not a bad time to reorganize the portfolio.”
Utilities are losing power. Bank stocks are buckling. And high-flying income trusts have come in for a hard landing.
How do you like rising interest rates so far?
After enjoying years of interest rates that were visible only with an electron microscope, investors are suddenly being yanked back to reality. Central banks are signalling that the low-rate party is about to end, and bond yields are already heading up as signs of economic growth return.
That is delivering a bodycheck to interest-rate-sensitive stocks -- which form the bedrock of many investment portfolios.
Bank of Montreal, for instance, is down 13 per cent since January. Enbridge Inc. is off 9 per cent since mid-March. RioCan Real Estate Investment Trust is off 15 per cent since early March.
Rising rates crimp bank profits, raise borrowing costs for utilities and make the shares of both less attractive, because the dividends don't look as juicy compared with a risk-free term deposit.
But just because interest rates are rising doesn't mean your blood pressure has to. By taking some preventive medicine now, investors can limit the damage caused by rising rates, financial advisers and portfolio managers say.
"We're looking at interest rates going up sooner rather than later," says Adrian Mastracci, president of Vancouver-based KCM Wealth Management Inc. "This is not a bad time to reorganize the portfolio."
Most advisers agree on one thing: Steer clear of long-term bonds. For the fixed-income portion of your portfolio, it's wise to keep maturities to about five years and under, creating a ladder that allows you to reinvest a portion of your money each year at progressively higher interest rates.
The danger of going long is that you could wind up with a big capital loss if you have to sell your bonds before they mature, because bond prices fall as rates rise.
"What we're counselling our clients to do . . . is stay at the shorter end of the yield curve where you're less vulnerable to price decreases," says Michael Herring, managing director and fixed-income strategist.
How high will rates go? Mr. Herring expects the U.S. federal funds rate -- the rate at which banks make overnight loans to each other -- to climb to about 4.5 per cent over the next two years, up from its 45-year low of 1 per cent.
Over the same period, he sees the Bank of Canada raising its trend-setting overnight rate to 4.25 per cent from 2 per cent.
Bond yields have already spiked, with the 10-year Government of Canada issue finishing the week at 4.62 per cent, up from less than 4.2 per cent in March, and the 10-year U.S. Treasury climbing to 4.5 per cent from about 3.7 per cent over a similar period.
Investors should also review the equity portion of their portfolios, says Marc Johnson, newsletter editor. Instead of putting new money into banks and utilities, they should look for consumer stocks that will benefit from an improving economy and hold up well in a market correction, he says.
Companies he likes include Loblaw Cos., Andres Wines Ltd., Corby Distilleries Ltd., and Canadian Tire Corp. Ltd. But don't rush out and sell your banks and utilities, he says. They should still comprise 25 per cent to 30 per cent of a well-balanced portfolio.
More sophisticated investors can look into floating-rate preferred shares, whose dividends rise and fall with the prime rate at chartered banks, he says. Power Financial Corp., Alcan Inc., BCE Inc., Brascan Corp. and Thomson Corp. are among companies that offer them.
"These are high-quality preferreds, which means it's unlikely they'll skip dividend payments. And as prime rises, so do the payments."
Another option is to set up a ladder of guaranteed investment certificates, with maturities ranging from one year to five years. He recommends buying GICs at smaller institutions, where rates are often higher than at the big banks.
Looking outside Canada is another way to cope with rising rates.
The S&P/TSX composite index is heavily weighted toward interest-sensitive issues, which means many Canadians are vulnerable to a rise in rates, says Andrew Martyn, vice-president and portfolio manager.
"Most people are overexposed to interest-sensitives, and I don't think it's a place to get deep into right now," he says.
Instead, he recommends looking for reasonably priced U.S. growth stocks that will benefit from an economic rebound. Companies that meet his criteria include: Autodesk Inc., whose AutoCad design software is used in industries worldwide; Anthem Inc., which provides health care benefits; and Ball Corp., which makes metal and plastic packaging, primarily for beverages and foods.
In Canada, there's Magna International Inc. "Frankly, the United States has more of a diversified list and better names than we do."
Although Mr. Martyn recommends staying away from Canadian banks for now, this may be a good time to hunt for undervalued income trusts that were hammered in the recent selloff.
"If you ask us if we believe in the increasing rate scenario, the answer is yes. The next question is what's the magnitude, and that's the big question out there," he says.
How to bullet-proof you portfolio
- Shorten bond maturities: Keeping maturities to five years or less will limit capital losses and allow reinvestment at higher rates.
- Don't overweight banks & utilities: These interest sensitive stocks tend to get hit when rates rise.
- Buy high-quality consumer stocks: Food, beverage and retail companies should benefit when the economy improves.
- Look into floating rate preferreds: These obscure securities offer a dividend that rises and falls with interest rates.
- Remain diversified: No matter which way rates are headed, having a balanced portfolio is still paramount.
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