It’s been a wild ride for Canadian preferred shares in the past two years. After a strong 2021, investors were met with a wave of interest rate hikes in 2022 that sent the S&P/TSX Preferred Share Index into a 16.5 per cent decline. But what does 2023 have in store for the Canadian preferred share market? In this report, we take a look at what to expect in the upcoming year and what it may mean for investors.
What to expect for interest rates in 2023
The U.S. Federal Reserve is widely expected to keep increasing its overnight rate throughout the year, reaching five per cent or even higher. The Bank of Canada is also expected to continue raising its overnight rate, though the exact amount is uncertain.
Some forecasts see the rate increasing to 4.5 per cent, while others expect it to reach 4.875 per cent. However, Royal Bank and Scotiabank both predict a rate decrease by the end of 2023.
The impact of interest rates on preferred shares
The movement of interest rates in 2022 had a significant impact on the performance of Canadian preferred shares. Most of the Canadian preferred market is made up of rate-reset preferreds, which are sensitive to interest rates. As rates increased, rate-reset issues and floating-rate issues both took a hit. However, our recommended floaters still outperformed the S&P/TSX Preferred Share Index.
Straight perpetual preferreds, which pay a fixed dividend, were also impacted by the rate hikes. Since the dividend is unchanging, their share prices become vulnerable to increasing interest rates. As a result, these preferred shares saw a 16.3 per cent decline in total return in 2022.
What to expect for 2023
If interest rates begin to fall by the end of 2023, as some forecasts predict, then the performance of Canadian preferred shares could improve. Straight perpetual preferreds, in particular, may benefit from a decrease in interest rates as their share prices become less vulnerable.
At the same time, the performance of rate-reset preferreds and floating-rate issues may still be tied to the equity market in 2023.
Investors should keep an eye on both the interest rate and the equity market in the upcoming year to get a better idea of how Canadian preferred shares may fare.
This is an edited version of an article that was originally published for subscribers in the January 6, 2023 issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
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Money Reporter •4/27/23 •