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The preferred share market in November followed a similar pattern as the previous month by declining for the first three weeks of the month before moving higher in the final week. In contrast, bond and equity markets were both lower for the first week of the month but then turned sharply higher with the release of the US CPI report that showed inflation declining slightly more than had been anticipated. If inflation continued to decline, it could allow central banks to soon stop raising interest rates and potentially begin reducing them again. That would mean less upward pressure on bond yields and a lower likelihood of a recession. Notwithstanding the risk on environment, preferred shares only turned higher the last week of the month aided by a somewhat unexpected redemption announcement. Over the balance of the month, the preferred share market recovered some but not all its losses. The S&P/TSX Preferred Share index ended the month with a return of -0.65%.
Canadian economic data released in November was generally strong. Canadian GDP grew at an annual rate of 2.9% in the third quarter which was much better than expected. However, domestic demand shrank modestly as the impact of higher interest rates and inflation deterred spending. Job creation in October was robust, particularly for full time positions, and as this is being written the unemployment rate for November has edged lower to 5.1%. Year-over-year inflation reported for October was 6.9%, a level that has only declined by 0.1% over the past three months despite the Bank of Canada aggressively increasing interest rates since March. The next rate decision for the Bank of Canada is on December 7th, when it is expected to raise the overnight rate potentially by 50 basis points to 4.25%. However, a smaller 25 basis point increase is possible, as the Bank has been steadily reducing its increments since it raised rates by 100 basis points in July.
As mentioned above, in the last week of the month, Northland Power Inc. announced that on December 31st it will redeem the $120 million NPI.PR.C series, which has a reset spread of 346 basis points. This somewhat unexpected redemption, as the shares closed the day before the announcement at more than a $1 below their $25 par value, seemed to give a boost to the market. One reason the market was somewhat surprised by the NPI.PR.C redemption was that National Bank, a stronger issuer than Northland Power, decided only a month earlier to extend rather than redeem its NA.PR.C shares that had a nearly identical reset spread of 343 basis points. As this is being written, the four other preferred shares (BAM.PF.J, BAM.PR.Z, BPO.PR.I and IFC.PR.A) that have reset dates at the end of December have also been extended.
During the month, there were no new issues. The previously announced redemption of the $300 million PPL.PF.C series occurred on November 15th.
In November, BCE Inc. announced that as of December 1st, its BCE.PR.Z shares will have a new dividend rate of 5.364% for the next five years. Subsequently, the company announced that 137,274 of the BCE.PR.Z shares were tendered for conversion into the floating-rate BCE.PR.Y series. At the same time, 1,196,313 of the BCE.PR.Y shares were tendered for conversion into BCE.PR.Z series. Consequently, going forward, BCE will have 2,977,548 BCE.PR.Z and 7,020,252 BCE.PR.Y shares outstanding. The BCE.PR.Y shares will continue to pay a monthly floating rate dividend based on the prime interest rate.
BCE Inc. also announced its intention to renew its normal course issuer bid (NCIB) to purchase up to 10% of the public float of each series of its outstanding preferred shares that are listed on the TSX. The period of the NCIB will extend from November 9, 2022 to November 8, 2023 and BCE will pay the prevailing market price at the time of acquisition. Under its previous NCIB that expired on November 8, 2022, BCE did not purchase any preferred shares.
National Bank of Canada announced that none of its outstanding 16,000,000 NA.PR.C shares, which it elected in October to extend, would be converted into the floating rate preferred share option. The annual dividend rate for the NA.PR.C shares for the next five years will be 7.027%.
The seven largest preferred share ETFs continued to experience net withdrawals in November, with total outflows of $92 million. Preferred share trading conditions continued to improve from the low volumes experienced in the summer months, with several days in November experiencing above average daily trading volumes.
J Zechner Associates Preferred Share Pooled Fund
The fund returned -0.43% in November, faring slightly better than the S&P/TSX Preferred Share Index. The outperformance can be partially attributed to the announced redemption of the portfolio’s position in NPI.PR.C, as these shares started the month at $1.50 below their $25 par value and finished slightly above it as investors anticipated the final dividend payment.
During the month activity was light, however late in the month we added to some existing perpetual preferred share positions (CU.PR.E, GWO.PR.R, and PWF.PR.L) and started the switch from the RY.PR.N position into additional IFC.PR.K shares to pick up additional yield. All of these perpetual preferred shares had yields greater than 6.25%, which we believed provided good relative value.
Outlook and Strategy
Although Canadian economic growth has slowed, it remains positive. The labour market remains tight, with low unemployment and historically high growth in average hourly earnings. Employers are being forced to raise wages to retain and attract new staff. Given that wage growth tends to lag inflation, particularly in negotiated contracts, it is likely that relatively high wage inflation will be present for the next few quarters at a minimum. Inflation remains well above the 2% target, and while some factors behind the surge in inflation have improved, others have not. Although inflation may not be as entrenched as in the 1980s, it has remained persistently high for several months.
The Bank of Canada is focused on inflation and until inflation comes down to at least 3%, we think it unlikely that the central bank will want to ease its restrictive monetary policy. With additional rate increases likely in December and possibly early 2023, we believe the recent decline in bond yields will be at least partially reversed. Even without any additional increase in bond yields, rate reset preferred shares, particularly those that are resetting in early to mid-2023, continue to look attractive.
The risk of a recession has increased substantially because of the interest rate increases this year. The severity and length of a recession are very difficult to predict, but the need for the Bank of Canada to keep interest rates high until it is assured inflation has been brought under control argues against monetary easing until late in 2023, at the earliest. Should a recession begin soon and last through next year, we believe corporate profits will be negatively affected. However, we remain confident in the creditworthiness of the issuers in the portfolio, as these companies have successfully weathered previous economic downturns without impacting their ability to pay the dividends on their preferred shares.