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Also available in PDF: McMurtry Investment Report – March 2023

Investment Commentary March 2023


US Yield Curve


The inversion of the 10-2-year US Treasury yield curve has increased marginally to a negative 89 basis points on March 3rd from last month’s rate of negative 77 basis points.


US Corporate Debt Spreads


Corporate debt spreads have stayed stable from last month at 1.82%. These spreads are much lower than the 4.3% in 2020 or the 6% plus level in the recession of 2008. This narrowing indicates the strength of the domestic US economy.


China and Covid


Corporate debt spreads have stayed stable from last month at 1.82%. These spreads are much lower than the 4.3% in 2020 or the 6% plus level in the recession of 2008. This narrowing indicates the strength of the domestic US economy.


Equity Market Valuations


The PE of the S&P 500 index is currently at 17.9 times this year’s earnings per share.


Central Bank Monetary Policy


Over the last month inflationary pressures have picked up with both rising CPI and PCE numbers. In addition, January’s employment was surprisingly high, almost double the consensus numbers. This has caused the Federal Reserve to remain hawkish and tone down any comments about a possible Fed pivot regarding interest rates.


Asset Mix


In this month’s newsletter, I reviewed all the current headwinds and tailwinds that may affect security market prices. It is far too easy simply to remain overly defensive at this juncture. The US economy is behaving quite well despite the rise in interest rates over the last year. Employment remains strong and retail sales are rebounding. The Chinese economy is gradually picking up after exiting all the lockdowns associated with Covid. All the negative effects from a hawkish Fed have not been totally felt yet by the economy and the outlook for inflation. It is just a matter of time before inflationary pressures ease off once again and economic and employment growth moderates.


Given all these conflicting trends, I have decided to increase the equity weight for both portfolios by 5%, back to 43% and 53% respectively for the Income and Growth portfolios. Cash is going back down again to 21% for both portfolios. At this point my equity exposure remains neutral, but is becoming more positive as markets digest all this news. We all know how much worse the average Canadian and US stock price performance is relative to the equity benchmarks. In addition, we also know that corporate earnings are declining year over year, but not to the extent that the most extreme bearish strategists and economists are predicting.

Equity Sector Weights


I indicated in this month’s newsletter that the Federal Reserve may not be able to reduce domestic inflation back down to their target of 2% annually. This is because they have a dual mandate of keeping both inflation low with stable employment growth. Destroying the economy and creating heavy unemployment simply to get inflation back down to the 2% level is not a great strategy for the Central Bank to follow. At some point over the next 3-6 months, either employment and CPI begin to back off making a Fed pivot much easier, or the Central Bank finally concludes that inflation of 3-4% is acceptable in this current environment. In either circumstance, the outlook for value stocks and Canadian ones remains more favourable than for US growth stocks.


Taking these issues into consideration, I have decided to reduce Healthcare, Staples and Utilities from market weight to underweight. At the same time, I am increasing the Consumer Discretionary and the Industrials sectors to overweight from market weight.


I remain overweight Energy, Industrials, and REITs. I am keeping Materials at market weight at this time, but fully expect over the next few months to be increasing my exposure.


I remain at a small underweight in Financials as well but am keeping a close watch with the intent of increasing my exposure to this cyclical sector as well at some point.


I am keeping both Technology and Communications at underweight but am fully aware of how much these sectors have run back up recently with the possibility of interest rates eventually peaking out.


I do not feel that the tech stocks will lead the next upturn of this market, but do not expect them to fall materially from current levels.

Individual Equity Changes


On February 16th I posted a portfolio blog adding Element Fleet to both portfolios in the Industrials sector. This company was spun off in 2016 from Element Financial and has grown into one of the world’s largest fleet managers of cars and trucks. The company has totally transformed itself by changing the way it buys vehicles through syndicating its auto loans to insurance companies. By taking this approach the company has materially reduced its amount of leverage used and this in turn makes them much less vulnerable to rising interest rates. In addition, the company has expanded its operations from buying and financing vehicles to maintenance, fuel and conversion to electric fleets. The shares are trading at a reasonable PE on this year’s earnings of 16.62 times and offer a dividend yield of 2.05% that is well covered by cash flow.


On February 22nd I posted a portfolio blog adding Alamos Gold to both portfolios in the Materials sector. The shares are trading at 9.3 times Enterprise Value to forward EBITDA and the company has a very healthy balance sheet with no long- term debt. Earnings per share are expected to increase by 10% this year from a 4% increase in production combined with a 7% reduction in unit operating costs. The company offers a dividend yield of 0.96%.


On February 22nd, I posted a portfolio blog deleting Air Products from both portfolios. I recommend investors use the proceeds to buy more shares of Linde, a competitor of Air Products. EPS consensus estimates continue trending up for Linde, while Air Products is not indicating the same improvement.


On March 3rd I posed a portfolio blog adding the Canadian property and casualty company, Definity to both portfolios in the Financials sector. The company has been operating for 150 years and offers personal auto and home as well as commercial and pet insurance. Their insurance is sold either through brokers or through its online Sonnet platform. The 4th quarter saw year over year growth in premiums of 11.3%. Projected growth this year in revenues and EPS is 9% and 12% respectively. The shares trade at a reasonable 15.65 times this year’s earnings which is comparable to Intact. However, the projected growth rates are better for Definity. In addition, the company has applied to the Minister of Finance to convert to a CBCA. This will enable the company to increase its leverage and make more accretive acquisitions. The shares offer a dividend yield of 1.55%.


Lastly, I am adding a new US company, AGCO to both portfolios in the Industrial sector. The company is one of the largest producers and distributors of farm equipment in over 140 countries. It produces tractors, combines, self propelled sprayers, hay tools, grain storage and protein production systems. Familiar brands include Massey Ferguson, Challenger, Fendt, and Precision Planting. During the 4th quarter and 12 -month periods, revenues rose 23.6% and 13.6% respectively. EBITDA is expected to rise by 11% this year. The market valuation using Enterprise Value to forward EBITDA is a reasonable 6.6 times, much cheaper than Deere’s 13.91 times. The company has a strong balance sheet with financial debt at only 1.336 times trailing 12 -month EBITDA. The company offers a free cash flow yield of 4.16%. Although the company’s EBITDA is projected to grow at 11% this year compared to Deere’s 20% projection, the much cheaper valuation more than makes up for the slower growth prospects. The dividend yield of 0.67% is more than sufficiently covered by operating cash flow. The company’s Precision Planting Division is focused on products that improve planning for its customers through either retrofitting equipment or making products that improve planting solutions.


Even though US crop prices are off last year’s highs, they are still expected to remain well above historical averages. The Department of Agriculture in the US estimates that the expected net cash farm income will be $150.6 billion this year adjusted for inflation, down from last year but significantly higher than the 20- year average of $130.5 billion adjusted for inflation. There is a growing need to replace aging farm equipment to improve productivity and lower operating costs, especially labour. The US agricultural machinery market is expected to grow at a compound annual growth rate between 2021 and 2027 of 3.3%. Farmers are relying more on advanced new technology to create smart farming solutions through mechanization to reduce costs and increase crop yields.

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