Dividends have been harder to come by since 2013, says Andrew Zimcik, a member of the fundamental equity team at Connor, Clark & Lunn Investment Management in Vancouver. Over the last few years, he finds “about 75 companies in Canada have either cut or eliminated their dividend[s]. The TSX composite index has just over 250 companies, [so] that’s not a particularly great track record.”
Many of the cuts came from the energy and materials sectors, he adds, but almost half in the last few years came from sectors such as financials and industrials. In those cases, “management teams can’t squarely place the blame on falling commodity prices,” says Zimcik, who spends just as much time researching companies that could offer strong dividends as those that could potentially cut them.
Zimcik, whose firm manages the Renaissance High Income Fund, explains, “There are lots of good companies in Canada that don’t have business models well-suited to paying dividends, and those are the companies we […] avoid.” In addition to companies subject to commodity prices, he avoids those that are exposed to large swings in the market and economy as well as those with over-levered balance sheets, noting, “they can’t sustain a higher dividend payment.”
Regarding companies in the energy and materials spaces, he says, “It’s nice to own those companies when commodity prices are going up and the equity market’s going up, but it’s a lot nicer not to own them when [commodity prices] are going down.”
What’s next for markets?
With markets continuing to climb, could a downward trend be on the way?
“Given the strong performance in the equity markets since the U.S. election, we wouldn’t be surprised to see a modest pullback soon — something in the 5% range,” says Zimcik.
Several signs would indicate a longer-term downturn, he continues. “The main indicator is the underlying strength in the [U.S.] economy, and, by correlation, the Canadian economy.” At this stage, he says “economic growth continues to move in the right direction, which is exactly why […] we have seen such strength in equity markets for the last six months or so” — but a reverse would be negative.
He also keeps track of purchasing managers’ index (known as PMI) indicators, inflation expectations and other survey-based leading indicators. If they begin to soften, “we’ll start to think about positioning for a more sustained or larger pullback. We’re keeping a close eye on the relative strength of survey data and real indicators.”
Zimcik says surveys are beneficial, as they indicate anticipated management behaviour, such as CFO plans for capital expenditures. “We’ve certainly seen capex expectations increase as management teams and CFOs expect that higher economic growth will benefit higher spending in their businesses,” he says.
For example, expected capex in the energy sector is on the rise for 2017. “Eventually, we need to see […] the plans to spend on capex materialize. So far, the optimism in surveys has been slow to translate into real, hard data. If this doesn’t follow through eventually, then the market levels could be at risk.”