Also available in PDF: McMurtry Investment Report Portfolio – April 2022
Investment Commentary April 2022
US Yield Curve
For the first time since July, 2019, the 10-2 year US Treasury yield curve actually inverted to the current level of minus 0.06%, from last month’s already low 0.24%. The US Federal Reserve has become much more hawkish and this has resulted in short rates rising much faster than longer term maturities. US domestic inflation is at the highest level in many years propelled by the continuation of goods supply shortages, rising labour costs and record high commodity prices.
This inversion of the yield curve has frequently been a good signal of an impending recession. However, this indicator may prove not to be nearly as reliable as in the past with the massive Central Bank bond buying of longer dated maturities. Nevertheless, this inversion should still put all investors on high alert for a slowing of economic growth later this year and next.
US Corporate Debt Spreads
As of March 31st 2022, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually narrowed modestly by 31 basis points to the current level of 1.93%. This narrowing is in sharp contrast to the inversion of the yield curve and most likely indicates that more evidence is needed before predicting a recession in the near future.
Covid – 19 Health Stats
All the recent pressure by the truckers in both Canada and the US led to all levels of government backing off on mandated pandemic lockdowns. This is now resulting in an increase in the number of Covid cases and is a clear signal how short sighted the truckers were. Fortunately, most of these new cases are much milder than previously and are not resulting in a sharp increase in hospitalizations.
Equity Market Valuations
The forward PE multiple of the S&P 500 is 19.60 as of April 1st compared to 19.2 times last month and the long- term average of 19.6 times.
Central Bank Monetary Policy
Faced with rising inflationary pressures, the US Federal Reserve Bank remains totally committed to controlling inflation by reducing the balance sheet and increasing interest rates.
The combination of increased geopolitical risk from the Ukraine war, a very hawkish Federal Reserve, less accommodative fiscal policy, sharply rising energy and commodity prices, and a labour shortage is creating a great deal of uncertainty regarding the sustainability of this economic cycle. A recent inversion of the 10 less 2 year US Treasury yield curve also adds to the uncertainty.
Consequently, I am recommending an increase in my cash weight of 5% for both portfolios to a new level of 30%, with equities simultaneously being reduced by the same amount.
I am also increasing my Canadian North American equity benchmark percentage by 5% to the new level of 75% Canada and 25% US. As highlighted in previous newsletters and blogs, the outlook for Canadian equities in a rising commodity environment is much more favourable than is the case for US equities.
I am reducing the European equity weight to 3% for both portfolios, largely based on the Euro being much more susceptible to rising energy prices than North America.
I am increasing my GIC weight to 5% for both portfolios. I am replacing my real return fixed income exposure by deleting the US Tip ETF and adding the iShares Floating Rate ETF XFR as a replacement. The latter ETF is priced in Canadian dollars. Lastly, I am reducing the high yield weight to 2% for both portfolios. This is predicated on a gradual reduction in overall economic growth but no immediate recession on the horizon.
Although it is much too early to predict an economic recession, all these headwinds will clearly result in economic growth slowing somewhat this year and next. Having some extra cash will provide a nice cushion from falling markets and also provide an opportunity to add to your equity exposure as market opportunities unfold.
Equity Sector Weights
While I remain overweight Financials, Energy, Materials, Industrials, Consumer Discretionary and Reits, I am making some adjustments to these overweight positions. Based on the negative effect that higher rates and rising commodities have on the consumer, I am reducing my Consumer Discretionary overweight, but still remain overweight. I am doing the same thing for Financials, Industrials and Reits. On the other hand, I am reducing my under exposure to Healthcare and Utilities sectors. I remain underexposed to both the Technology and Communications sectors.
Individual Equity Changes
In a blog dated March 8th, I added Old Dominion Freight to both portfolios in the Industrials sector. The company is one of the largest trucking firms in the US and has a solid balance sheet with strong EBITDA and Revenue growth prospects this year. The company is also a consistent dividend grower despite its low dividend yield.
In the technology sector in a blog dated March 3oth, I added Micron Technology to the Growth portfolio. The company recently reported year over year growth in its fiscal 2nd quarter of 25% in total revenues. EPS also rose sharply to $2.14 per share compared to $0.98 last year. Revenues are expanding as a result of the switch to the business cloud and the rapid increase in data center activity. This latter trend is getting a lot of help from the increase in bitcoin production.
After the addition of Micron, I will have three companies in my model portfolios exposed to the semiconductor industry, namely Applied Materials, Qualcomm and Micron Technology. Consequently, I have decided to delete the US semiconductor ETF, XSD.
In a blog dated March 11th, I recommended a switch out of Allstate into Chubb in the property and casualty insurance industry. Chubb is expected to grow its EPS at a much faster clip than Allstate, yet its valuation is only marginally higher.
Finally in a blog dated March 18th, I added Hudbay Minerals to the Growth portfolio. The company is a major producer of copper and gold with operations in both Canada and Peru. The company is trading at a reasonable valuation relative to its peers and is expected to see strong production growth in both copper and gold over the next two years.
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