Some thirty-five years ago when I was working for a bank, one of my managers taught me the secret formula for life as a banker.  “3 6 3” he told me. “Pay your depositors interest of 3%. Loan out money to your borrowers at 6%. Be on the golf course by 3pm.”  If only life were so simple today.

In the past five years there has been an unprecedented change in interest rates, not only in North America, but around the world. As a result of actions by central banks, most developed world governments, and major corporations, interest rates have fallen to record lows. The Government of the U.S. can today borrow money for about 1.35% for ten years.  The Canadian Government can do even better, paying just under 1% for ten years. In Europe, the Swiss will charge you money for making bank deposits, and 30 year Swiss government bonds pay interest of 0.1% per year. About $10 trillion of sovereign debt pays negative interest rates.

The hyper-low interest rates have been wonderful for home-buyers and consumers.  Fixed rate mortgages are available at interest rates as low as 2.3%, which seems unbelievable to anyone over 40. Automobile purchase loans are available at under 3%, which is great for car makers. But what is a blessing for borrowers is a curse for savers.

Gone are the days when the bank on the corner would sell a five year Certificate of Deposit paying 5%. Today that same bank will offer you 1.5%, or perhaps even as much as 1.75%.  Bond funds strain to produce returns over 2%.  With consumer inflation running around 1.5%, savers and bond buyers are getting a real return close to zero, without even taking taxation into consideration.  

Investing in CDs, bonds and money market funds had long been the sweet spot for older investors and those worried about stock market volatility. Returns might not have been wonderful, but at least there was no risk of losing money. Knowing the interest rate that would be paid provided a sense of security and made planning easier.  Now, however, that sense of security has gone up to such a high price that it is unaffordable to most savers. Those who need a return from their portfolio to maintain their life styles simply can no longer get it from the fixed income market. Those who persist find that they must either eat into capital, or curtail their spending; both are unpalatable choices. What was sweet has turned sour, and old ideas about investment, about risk and return, simply do not work in this environment.

Recent pronouncements from central banks in Canada, the US, Britain and Europe have made it clear that interest rates will rise slowly, if at all, over the next few years. In today’s world, risk adverse investors need to expand their horizons. Stock market volatility can be scary, or as was the case in 2008, terrifying. But it is a fact that even with the inevitable market crashes and crises along the way, stocks tend to rise over time.  Even the disaster of 2008/09, the worst stock market crash since the 1930’s and during which the S&P 500 fell 50%, took only about two or three years to repair. Most market events are much less dramatic and over the long haul, amount to mere blips on an upward sloping line.

Our belief is that in a world of low economic growth and low interest rates, dividends will command a level of attention and importance that they last saw in the early part of the last century. Stocks will be held not only because they may increase in value, but as much or more because they pay dividends which provide a better return than bonds. The best stocks to own will be the ones which are the most reliable dividend payers and dividend growers, and investors will pay a hefty premium to own these kind of securities. Over the past forty years, dividends have provided 1/3rd of the total return for investors in the S&P 500 and about ½ of the return for investors in the S&P/TSX.  We would not be surprised to see dividends account for more than half of all returns on US markets in the coming years.

It may seem odd to be moving towards greater weightings in equities at just the time that the US markets are hitting record highs. Investors should realize that there is a good reason for those highs – bonds are being sold and stocks are being bought, a trend we expect to last for a long time. We will continue to be diligent in seeking out value and protection for our clients, and in our view, that is more likely to be found in high quality stocks than in bonds.

David Baskin July 13, 2016