Investing in U.S. bonds is like trying to catch rain water in the Sahara. You’re thirsty for some kind of cash yield, but with ten year government bonds paying less than 1.5 percent, you may be tempted to hunt for an alternative. Consider most of those options, however, as desert mirages.
Round the first dune and you might catch the glorious view of a Canadian bank stock with a mouth-watering dividend. Canadian banks sidestepped the sub-prime mortgage mess. Their shares (available on the NYSE) have gained more than 200 percent over the past decade—not including dividends. Add cash payouts that double or triple U.S. bond yields, and it’s easy to see the temptation. TD Bank is paying a 3.6 percent dividend. The Royal Bank pays 4 percent; Scotiabank pays 4.3 percent; and CIBC pays 5 percent. So where’s the risk? In the currency exchange.
Let’s take TD Bank for starters. On the surface, it looks great. Shares have gained 250 percent over the past decade. It trades at 11.8X earnings and boasts a dividend yield of 3.6 percent. So far so good. But U.S. shareholders could lose plenty of money if the Canadian dollar falls. The advertisements trumpeting TD as “America’s most convenient bank” are somewhat misleading. It’s Canadian.
If you bought TD bank shares, you could lose money if the exchange rate changes. Its stock trades on two markets: the Toronto stock exchange and the New York stock exchange. Imagine the share price remaining unchanged on the Toronto stock exchange, five years from now. In that case, Canadians would earn the 3.6 percent dividend, and no capital gain. But if the Canadian dollar dropped 20 percent, American shareholders would lose money.
Currently, the two currencies are at par—one U.S. dollar is roughly equivalent to a Canadian dollar. But during most of my lifetime, the loonie (as they call it in Canada) has languished 20 percent below the U.S. dollar. If Canada’s dollar drops back to its historical range, TD shares will drop 20 percent on the U.S. market. A 3.6 percent dividend wouldn’t console anyone after a 20 percent drop.
Consider the possibility of the Canadian dollar falling. The Economist suggests that Canadians are carrying a larger debt load than Americans did, before the 2008/2009 crash, and that Canadian real estate is more overvalued than the U.S. market was at its peak. Canadian home prices are at extraordinary levels with the average home fetching $375,810. A 41 year old, 2,565 square foot home in Vancouver recently sold for $1.7 million. And no, it wasn’t lakefront, oceanfront or riverfront. Check out the link to view it yourself. Rising interest rates could spoil the party if the sadly familiar foreclosure tune sweeps the country.
Reaching for greater yields on foreign soil can always backfire. Take the iShares short term international Treasury bond ETF yielding 4.6 percent. It’s paying nearly triple the yield on a U.S. bond, but the U.S. dollar has gained 12.5 percent on the Euro in the past 5 years. If this currency trend continues, the 4.6 percent yielding bond index wouldn’t earn any more than a U.S. bond over the next five years. And if the Euro falls back to its 2002 level (20 percent below its current rate) U.S. shareholders would actually lose money—despite the dividend.
International diversity is fine (in small amounts) but wasting energy in the hunt for a high yielding foreign oasis could leave you with a mouthful of sand instead.