The preferred share market started the new year, as it ended last year, with another strong month in January. The good result came despite the financial market volatility created by the potential for the incoming U.S. administration’s policies to cause higher inflation while failing to address its massive budgetary deficit. Canadian investors also became concerned that the 25% tariffs threatened by President Trump would hurt the Canadian economy. However, preferred share performance continued to be supported by redemption activity. While there were no new redemption announcements in January, early in the month, investors received $225 million from the redemption of the L.PR.B series and $26 million from the redemption of the PPL.PF.B series. In addition, on the final day of the month, investors received $800 million from the redemptions of the CM.PR.P and TD.PF.C series. All types of preferred shares had positive average returns in the month, with rate reset issues earning 2.6%, floating rate issues gaining 4.5%, while perpetuals lagged with a return of 2.0%. The S&P/TSX Preferred Share index ended the month with a gain of 2.25%.

Canadian economic data received in January had less impact on the market than usual because of the focus on Trump’s threatened tariffs. However, there were some significant indications that the Canadian economy was strengthening. The unemployment rate declined to 6.7% from 6.9%, partially due to a drop in the participation rate, but also due to 90,900 net new jobs being created, which was the largest increase in nearly two years. The inflation rate declined to 1.8% from 1.9% in the previous month but would have jumped to 2.3% if not for the temporary GST/HST holiday. In addition, StatsCan’s preliminary estimate for Canadian GDP in the fourth quarter showed it accelerating to a 1.8% annual rate, fast enough to begin using up the economic slack. The Bank of Canada lowered its interest rates by 25 basis points at its January announcement date, slowing the pace of reductions from the 50 basis point cuts at the last two announcements. Of note, at a discussion following the rate cut, a Deputy Governor (who participates in the rate decisions) said that the low interest rates that existed prior to the pandemic were unusual, implying that we are unlikely to see rates that low in the foreseeable future.

There were no new issues of preferred shares in January. During the month, three series of preferred shares reset their dividends. Dividend rates continue to reset significantly higher because the 5-year Canada bond yield is substantially higher than five years ago. Details of the resetting issues were as follows:

During the month, BCE announced, despite more than 40% of BCE.PR.E floating rate series investors choosing to switch back into the fixed rate BCE.PR.F series, there was sufficient remaining interest in the monthly pay prime-based floating rate series, and it would remain outstanding. Effective February 1st, there will be 3,339,629 BCE.PR.E shares and 11,250,771 BCE.PR.F shares outstanding. Also, as this is being written, Emera Incorporated has announced insufficient investor interest in making the switch to the floating rate series and all EMA.PR.F shares will be fixed rate ones for the next five years. The Bank of Canada interest rate cuts since June of last year have almost erased the advantage that floating rate dividend rates have had over fixed rate ones for the last two years, thus depressing investor interest in switching into floating rate issues.

Also in January, Manulife Financial announced that it does not intend to redeem its MFC.PR.N series of preferred shares. The new dividend rates will be announced on February 18th and investors will have until March 4th to make their decision to remain in the fixed rate series or switch into the floating rate series.

The trend of monthly outflows from the seven largest preferred share ETFs, which had every month in 2024 having net withdrawals, continued with an aggregate outflow of $95 million in January.

J.Zechner Associates Preferred Share Pooled Fund

In January, the fund returned 1.40%, which trailed the S&P/TSX Preferred Share index. The fund’s performance was negatively impacted by two factors. The fund held relatively more perpetual type preferred shares, which had the lowest sector returns for the month. In addition, despite having positive returns for the month, the fund’s approximate 11% allocation to institutional preferred shares and LRCNs was a drag on performance.

Portfolio activity during the month was limited to switching the BCE.PR.A position into the BCE.PR.F series to pickup 40 basis points in yield with the new dividend rate.

Outlook and Strategy

U.S. President Trump’s narcissistic love of attention and willingness to abrogate all established norms, including a trade deal he negotiated in his first term, suggests that we are in for an extended period of volatility. As this is being written, the threatened tariffs have been postponed for 30 days. The threat to impose 25% tariffs on almost all Canadian exports to the United States because of the very small amount of fentanyl crossing into the United States from this country was akin to trying to swat a fly with a very large sledgehammer. But, having successfully forced both Canada and Mexico to respond to his concerns, we suspect Trump will use the threat again at some time. However, having seen some of the potential retaliatory measures, and understanding his country’s need for Canadian oil, gas, and electricity, we believe the 30-day reprieve on the tariffs is more likely to be extended than imposed. The threat of tariffs will remain a significant risk, though, until the massive U.S. fiscal deficit is adequately addressed. In addition, Trump has ordered a review of U.S. trade relationships for any “unfair” practices by April 1st.

If U.S. across-the-board Canadian tariffs are not imposed, we believe the Bank of Canada is close to pausing its series of interest rate cuts. On its next announcement date, March 12th, the Bank may choose to leave its rates unchanged or cut them by a final 25 basis points and indicate that it is unlikely to lower them further. Either way, current bond yields have little room to fall further. Only if the United States decides to impose tariffs and commence a trade war, do we expect the Bank of Canada to make substantial reductions from the current level of interest rates.

The three January resetting issues increased their dividend rates more than 1.50%, and given that they trade below par, the increase in dividend yields was even greater. The 5-year bond yield continues to be substantially higher than five years ago, and we expect this to continue over the next few months. As we have noted previously, the fifth anniversary of the start of the pandemic, when the 5-year bond yield fell below 0.50%, is approaching. We believe the substantial increase in dividend rates on resetting issues, combined with the ongoing redemption trend, including the upcoming $300 million redemption of the NA.PR.W series in February, will result in the preferred share market continuing to offer attractive yields and potential for price gains over the next few months.

The market’s negative reaction to potential tariffs immediately before they were postponed suggests there is a substantial risk to the corporate sector if they are imposed. Despite this, we remain confident in the financial strength of the issuers in the portfolio, as these corporations have successfully paid their preferred share dividends during previous economic downturns.