Interest rates are falling across North America, from Canada to Mexico, and now the United States. The U.S. Federal Reserve’s recent 50 basis point rate cut on Wednesday signals a new era of less restrictive monetary policy. This shift in the investing landscape brings higher volatility, prompting investors to re-evaluate their strategies. Should you focus on passive income investments or Canadian growth stocks in September?
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Growth stocks vs. dividend stocks: Performance in a falling rate environment
While stocks generally perform well as rates fall, high-yield dividend stocks become particularly attractive. Lower interest rates translate to lower discount rates on future dividend cash flows, increasing the present-day value of passive income plays.
Utilities, real estate investment trusts (REITs), telecommunications stocks, and consumer staples often thrive in this environment. Highly leveraged businesses like utilities and REITs, which faced increased financing costs after 2022’s rate hikes, may benefit significantly.
Growth stocks can also perform well, especially if markets anticipate no recession. Their valuations, skewed towards distant future cash flows, increase as interest rates decline. Additionally, growth-focused companies, particularly Canadian small caps with negative cash flows, can access cheaper capital for ambitious projects and show better capacity to achieve overly bullish investor expectations.
However, economic outlooks play a crucial role. If unemployment rises and economic growth slows, growth stocks with weak fundamentals may suffer more than well-established dividend-paying companies with strong balance sheets and consistent dividend histories.
In essence, dividend stocks may be safer bets if their cash flows seem resilient. Growth stocks require a stable, growing economy to generate lucrative returns. Recessions typically aren’t friendly to them, even though declining interest rates often respond to slowing economic activity.
Stocks to buy in September: A passive income play
Canadian investors with potentially low stock-picking confidence or highly uncertain about September’s investing opportunities as rates fall may consider scooping a bundle of TSX dividend stocks through an exchange-traded fund (ETF). This approach can provide monthly dividend income and diversification across multiple positions in a single transaction.
The iShares S&P/TSX Composite High Dividend Index ETF (TSX: XEI) invests over $1.6 billion of its assets under management in about 75 Canadian dividend stocks, seeking long-term capital appreciation. It’s suitable as a core holding for portfolios that can carry medium-risk assets.
The XEI ETF offers a 5.1% dividend yield and it generated a stunning 15% total return over the past year, combining income and growth. Its low management expense ratio (MER) of 0.22% annually means investors pay about $2.20 per $1,000 invested per year in total expenses.
Top holdings include dividend stalwarts like TC Energy Corp, Royal Bank of Canada, Toronto-Dominion Bank, Enbridge, and telecommunications sector giant BCE.
Most noteworthy, the ETF provides diversified exposure to the Canadian economy, including a 31.2% exposure to Financial sector stocks, a 28.7% weight in Energy stocks, a 14.2% exposure to Utilities, and nearly 10% weighting towards the Communication sector. It’s a widely diversified bet on the Canadian economy that generates juicy passive income streams every month.
Investor takeaway
Both passive-income plays and growth stocks have their merits in a falling interest-rate environment. Your choice should align with your risk tolerance, investment goals, and economic outlook. For those seeking a balanced approach, a dividend-focused ETF like XEI could offer the best of both worlds: steady income and potential capital appreciation.
