Stock Market: What to Do When the Bond Market Tanks

The stock markets continue to set new records, and investors keep piling in, even though many feel prices are uncomfortably high.

It’s the same problem we’ve been facing for months — there are no acceptable alternatives. Bonds, which are the normal offset to stocks in a balanced portfolio, are having a bad year. As of May 28, the FTSE Canada Universe Bond Index was down 4.54 per cent year-to-date and we’re unlikely to see a reversal any time soon as inflation heats up. Bottom line: bonds look like a money loser for the rest of 2021.

You can avoid losses by moving to cash, but don’t expect much of a return. RBC is paying 0.05 per cent on its High Interest eSavings account. You can earn more at some smaller financial institutions, but many people are uncomfortable dealing with them, even though many have CDIC coverage.

What’s the solution? One strategy is to reduce the equity risk in your portfolio by using low-volatility, dividend-paying stocks in place of bonds. Think of them as bond substitutes.

The stocks to consider should have a low beta, which measures their level of volatility against the broad market. These will perform better when the market drops but will lag when stocks are on the rise. The market beta is 1.0 so the more the stock is below that, the less volatile it is.

The dividend payout will tend to provide a floor – companies try to protect their dividend to the extent possible, knowing that a cut will negatively impact the share price and erode investor confidence.

This does not mean that bond substitutes won’t lose value in a market plunge. But they will typically hold up better than the rest of the crowd.

Here’s a stock I consider to be a bond substitute. Prices are as of the close on May 28.

Emera Inc. (TSX: EMA)

Type: Common stock
Current price: $56.50
Annual payout: $2.55
Yield: 4.5 per cent
Risk: Lower risk
Website: www.emera.com

Comments: This utility is based in Halifax. Its business is primarily in regulated electricity generation and electricity and gas transmission and distribution. Emera has investments throughout North America, and in four Caribbean countries.

It’s not exciting stuff but the company is about as stable a stock as you’ll find. It has a beta of only 0.21, which means that if the broad market dropped 10 per cent, this stock should in theory lose only a little more than 2 per cent of its value. In the meantime, you’d continue to collect a quarterly dividend of $0.6375 a share, which is expected to rise by mid-year. The company has guided to annual dividend increases of 4-5 per cent through 2022.

The company started off the year with some solid numbers. First-quarter adjusted earnings per share increased by $0.17 to $0.96 driven by continued strength in the regulated portfolio, increased marketing and trading earnings and lower financing and other corporate costs, partially offset by a stronger Canadian dollar.

Emera plans to invest $7.4 billion in capital expenditures over the next three years, with the potential for an additional $1.2 billion over the same period. The company is forecasting rate base growth of 7.5-8.5 per cent through 2023. It is on track to invest more than $2 billion in 2021, increasing its rate base by 6 per cent to $22.5 billion.

For fiscal 2020, the company reported adjusted net income of $665 million ($2.68 per share), compared with $621 million ($2.59 per share) in 2019. The major contributor to the profit increase was the company’s investment in Tampa Electric, which contributed $501 million, compared to $419 million in 2019.

As I said, there is nothing exciting about this business. But its stable share price and decent yield make it a very attractive bond substitute.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe

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