Underweight cyclical stocks

By Vikram Barhat | November 1, 2012 | Last updated on November 1, 2012
2 min read

When stock market returns become unpredictable, dividends drive portfolio growth, says Domenic Monteferrante, first vice president of Canadian Equities at CIBC Asset Management. He manages the Renaissance Canadian Dividend Fund.

They’re often found in non-cyclical sectors. He expects bank, pipeline, telecom and utility stocks to maintain near-term dividend growth. “Last quarter, we saw five out of six major banks increase their dividends,” he says.

Read: Banks, telcos are good buys and Dividend stocks draw attention

Monteferrante also singles out the REIT sector due to its current average dividend yield of 5%, but warns its growth could be restricted due to rising payout ratios, which could go as high as 80%.

Read: Real estate investments preserve wealth

In the current environment, he suggests a portfolio that’s “defensively positioned with an underweight position in the more cyclical sectors such as energy and materials, and more overweight positions in consumer staples, telecom and financial services.”

Read: Paying attention to wave cycles

While uncertainty is part of any investment cycle, he says several factors are causing greater market volatility.

“Significant structural debt challenges in the developed economies will likely cause growth to be below normal,” he says. “This has caused central banks to implement a number of initiatives to stimulate the economy, including holding the interest rate low into the foreseeable future.”

However, that has done little to coax investors away from the sidelines.

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“One way to manage through this period is to continue to focus on the long-term fundamentals of the stocks and not to react to short-term events,” says Monteferrante.

To mitigate risk, he suggests a portfolio that maintains dividend yields above that of the market, and P/E ratios below that of the market.

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A dividend-oriented portfolio, though, risks losing value if there’s an unforeseen spike in interest rates — they would reduce the value of telecom, pipeline and similar stocks. Another risk: if companies put the brakes on dividends.

“You can lower this threat by having exposure to stocks that can provide some cyclical leverage; that have strong balance sheets and have the potential to grow their earnings and dividends.”

Vikram Barhat