Canadian Preferred Shares Report

Canadian Preferred Shares Report

October 24, 2019

Fixed Income Group

01-Jul-2019 08-Jul-2019 15-Jul-2019 22-Jul-2019 29-Jul-2019 05-Aug-2019 12-Aug-2019 19-Aug-2019 26-Aug-2019 02-Sep-2019 09-Sep-2019 16-Sep-2019 23-Sep-2019 30-Sep-2019

Inside this Report

Doves Fly South for the Winter......2 Prefs Go Where Yields Go ............2 Where to Look for Opportunities....2 Portfolio Positioning.......................3 Highlights: Sample Portfolio ..........4 Most Actively Traded .....................5 New Issues in Q3-2019 .................6 Appendix A: Yield Tables ..............7 Appendix B: Credit Ratings Comparisons .................................7 Appendix C: Education and Glossary ........................................8 Disclaimer .................................. 10

Doves Fly South for the Winter

Typical summer doldrums were non-existent in the third quarter this year as both equity and bond markets around the world saw spikes in volatility. Escalating US-China trade war tensions and no-deal Brexit worries have contributed to concerns of slowing global economic growth. With concerns on the rise, central banks, including the Fed, cut rates and global yields plummeted. In the month of August, the US 30-year Treasury yield hit a record low and the US yield curve inverted causing US recession worries to reverberate globally.

Despite all the geopolitical tension, Canada has been able to weather the storm with a housing rebound, good economic growth and one of the strongest job markets in recent times. At the latest Bank of Canada (BoC) rate meeting, the rates were left pat as expected due to stronger-than-expected growth and inflation being on target. Also, the BoC did not follow its global counterparts in signalling future cuts to their key interest rate. With the probability of a nearterm rate cut in Canada on the decline, the prospect of preferred shares has improved due to its positive correlation to yields.

Performance

120

115

110

105

100

95

90

S&P/TSX Comp TR

85

S&P/TSX Preferred Shares TR

80

Canadian Yield Curve

We remain overweight fixed-resets as we see good value in this area of the 3.00

market. We do remain cognisant that preferred shares can be volatile, especially with the proliferation of pref ETFs, and flows can exaggerate market movements 2.50

creating opportunities for investors. We also advise investors to hold some 2.00 perpetuals and high reset spread fixed-resets to help mitigate the risk of

potentially lower yields.

1.50

Phil Kwon Fixed Income

1.00

0.50 0

30-Sep-2019 31-Dec-2018 28-Sep-2018

5

10

15

20

25

30

Term (years)

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 10. Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2. 2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Probability of Rate Cut (%) Jan-2015 Apr-2015 Jul-2015 Oct-2015 Jan-2016 Apr-2016 Jul-2016 Oct-2016 Jan-2017 Apr-2017 Jul-2017 Oct-2017 Jan-2018 Apr-2018 Jul-2018 Oct-2018 Jan-2019 Apr-2019 Jul-2019 Oct-2019

Canadian Preferred Shares Report

Doves Fly South for the Winter

Over the past 12 months, yields have been declining over a concern of a global economic slowdown. The main cause has been the exasperation of the US-China trade war that has now been going on for 15 months. Brexit has been a secondary source of tension in Europe. On October 15th, the International Monetary Fund (IMF) made a fifth-straight cut to its 2019 global growth forecast, citing a broad deceleration across the world's largest economies as trade tensions undermine the expansion. The global slowdown has caused many central banks to cut interest rates in order to encourage growth.

BoC Looks to Keep Key Rates As Is

Overnight Rate

BoC Dates and Chance of a Rate Cut

9.0 8.0

100

Fed BoC

90

30-Oct-2019 04-Dec-2019

7.0

80

04-Mar-2020

6.0

70

5.0

60

4.0

50

3.0

40

2.0

30

1.0

20

0.0

10

0

Aug-2019

Sep-2019

Oct-2019

Source: Bloomberg, Raymond James Ltd.

The Fed, after 9 rate hikes from Dec 2015 to Dec 2018, has now cut rates in the past two rate announcements. The Bank of Canada, on the other hand, only had 5 rate hikes from July 2017 to Oct 2018 and has yet to cut rates. As seen in the second chart above, the probability of a rate cut in the next three BoC rate meetings has dropped significantly over the past two months. At the end of October, both the Fed and BoC will have rate announcements. Currently, interest rate markets are forecasting an 89% chance of rate cut for the Fed and a 1.4% probability for the BoC. At the last rate announcement on Sept 4, the BoC left rates unchanged as expected due to stronger-than-expected growth and on-target inflation meaning current levels of stimulus are where they should be. More importantly, the BoC did not follow its global counterparts in signalling an easing of monetary policy.

October 24, 2019 | Page 2 of 10

Prefs Go Where Yields Go

Fixed-resets constitute over two thirds of the preferred shares market in Canada. Thus the pref market is highly correlated to yields, in particular the GoC 5-year yield to which fixed-reset dividends are benchmarked off of. We believe that the GoC 5year yield will trend higher for the remainder of the year and therefore we continue to be constructive on fixed-resets. In Canada, the probability of a rate cut now has significantly diminished and if there continues to be progress between the US and China, additional rate cuts in the US could be taken off the table.

Since the end of August, we have seen improvement in yields globally with sentiment on the US-China trade war improving, albeit very slowly. With tensions easing, yields have been on the rise and quite substantially. The GoC 5-year yield which was near 1.2%, is currently above 1.5%. During this period, preferred shares were up nearly 5%.

Yields Have Been On a Wild Ride

130

3.0

BoC Rate Cut

120

BoC Rate Hike

2.5

110

S&P/TSX Pref Index TR (LS)

2.0

Govt of Cda 5-Year Yield (RS)

100

1.5

90

1.0

80

0.5

70

0.0

Source: Bloomberg, Raymond James Ltd.

Where to Look for Opportunities As we mentioned previously, there is a "sweet spot" in fixed-reset preferred shares, represented by the shaded area of the following table. These fixed-resets were either issued or their dividends were reset when the GoC 5-year was at record lows in 2015-2016. We believe there is an excellent opportunity to purchase some of these preferred shares which are looking to have their dividends reset higher at the

Canadian Preferred Shares Report

next reset date with an assumed GoC 5-year yield of 1.50%. Do delve a little deeper in each 6 month bracket, looking at credit quality, reset spreads and company sector, and select a fixed-reset appropriate for your risk profile.

Fixed-Reset Dividend Changes at GoC 5-Year Yield = 1.50%

Avg Div

Increasing Dividends

Reset Date (# Yrs Out) # Issues

Change

# Issues

% of Issues

................
................

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