By Fergal Smith
TORONTO (Reuters) – Canadian utility and real estate stocks are likely to be among the biggest beneficiaries of the Bank of Canada’s move to begin cutting interest rates, while the prospect of increased loan demand could help bank shares, investors say.
The BoC last Wednesday became the first G7 central bank to ease monetary policy, lowering its benchmark rate by 25 basis points to 4.75%. Roughly 150 basis points of additional cuts are priced into the bond market over the next couple of years.
Interest rate-sensitive sectors such as utilities, real estate investment trusts, or REITs, and financials account for 35% of the weighting on Canada’s main stock index, the S&P/TSX Composite.
“They’ve started cutting rates, there’s more to come,” said Joseph Abramson, co-chief investment officer at Northland Wealth Management. “The two big sector plays on that are REITs and utilities … they’re both income plays and they also have a lot of debt.”
REITs own income-producing real estate, while utilities include high-dividend paying pipeline companies such as Enbridge Inc and TC Energy Corp.
“The defensive parts of the market – think REITs, utilities and telecom – those areas have been hit particularly hard as rates have gone up,” said Mike Archibald, a portfolio manager at AGF Investments. “If rates go as consensus is thinking … those sectors I think would start to play a little bit of catch up.”
Canada’s economy is particularly sensitive to the level of borrowing costs. The mortgage cycle is shorter than in the United States, while household debt as a share of disposable income, at 174%, is much higher than the U.S. share of about 100%, OECD data shows.
The six major Canadian banks set aside loan loss provisions in their second-quarter results that were up 26% from the year before. Still, most lenders beat earnings expectations.
A move to lower rates “should spur demand for credit, which is clearly what drives the banks,” Archibald said. “We should in theory see an environment where banks start to attract a little bit more capital.”
The TSX has climbed 4.4% since the start of the year, helped by gains for energy and metal mining shares. But those sectors tend to be dependent on the global economic outlook, which has become more uncertain as the Federal Reserve delays the start of its rate-cutting campaign.
“Within Canada, I think you want those domestic interest rate plays. Utilities and pipelines, they’re not global. Those pipelines are right here and they’re very tied to rates.” Abramson said.
(Reporting by Fergal Smith; Editing by Andrea Ricci)
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