For many months we have noted the foreboding gap that was building between plunging real economy sectors (like materials and energy at lower purple arrow in first chart below) and still levitating, expanding leverage sectors like financials (in mauve at top) and real estate investment trust shares (REITs in black at top).
As interest rates plunged since 2011, income-seeking buyers kept herding into dividend paying equities. These companies meanwhile became obscenely overvalued even as their revenues turned down. Trying to keep the dream alive, they began borrowing funds to buy their own shares and maintain and increase dividends.
Think about it in practical terms for a moment. If your business is under pressure because revenues are falling, is the smart play to a) reduce your expenses and try to figure out ways to grow revenue or b) keep borrowing money so that you can pretend and extend and burn through cash on non-essential activities?
Well company management has been going with the short-term gain, long-term pain strategy inherent in option b) and now the short-term gain period has ended. As we can see in this next chart, stripping out payments made to holders since 2014, the share prices of dividend paying sectors (XFN, XRE and XDV) have been falling.
This should be taken seriously by those still hoping that income will be enough to make up for capital loses in the mean reversion phase. As can be seen in our first chart above, the wide chasm now under dividend paying sectors is huge and menacing for capital allocated there. And if historical correlations hold, the short term out-performance of these sectors and indeed the broader market (TSX in red top chart), is not long for this world. A catch-down period lies in the offing.
