Investment Commentary August 2021
US Yield Curve
The ten minus two- year US Treasury yield curve fell modestly to 1.10%. The recent flattening of the yield curve can be explained by the decline in the 10- year maturities. As the yield curve remains positive and is still considerably above December 31st level of 0.80%, this is not something to be concerned about in regards to the domestic US economy.
US Corporate Debt Spreads
As of August 5, 2021, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually widened very slightly by five basis points to 1.95%, compared to the same time last month This modest rise is not a sign of an impending recession.
Covid – 19 Health Stats
Relative to last month, the delta variant is rearing its ugly head resulting in more lockdowns both globally and in hot spots in North America. Daily cases in the US have shown a sharp increase to over 100,000. This cannot totally be a result of the delta variant, but is also an indication that many citizens believe that this pandemic is largely behind us and that social gatherings can totally resume as was the case before the pandemic. This is a very dangerous assumption taking into consideration that a large percentage of the global population has not been totally vaccinated. My conclusions is that global economic growth will be somewhat negatively affected, but remain on track for continued expansion, albeit at a slower pace until the world is completely vaccinated.
Equity Market Valuations
Taking into consideration the strong earnings growth with many companies exceeding expectations, the forward PE multiple of the S&P 500 index remains at 21.50 times, very similar to last month’s 21.3 times. This compares to the long -term median of 19.6 times.
Central Bank Monetary Policy
US central bank policy remains expansionary. However there is mounting pressure on the Federal Reserve to stop or materially reduce its ongoing bond purchases with inflationary expectations continuing to escalate.At some point the Federal Reserve may be forced to raise rates and it may be sooner than many expect at this time.
I am maintaining my high cash content at this time. More specifically the recommended high cash position would normally be allocated to the fixed income area. However, the probability of interest rate increases makes me very hesitant to advise a full allocation to fixed income at this time. Higher interest rates and higher inflation do not bode well for nominal bonds.
Equity Sector Weights
I am advising a material change in my North American benchmark equity weight from the current 60% Canada 40% US to 65% Canada and 35% US. I believe we are still mid cycle in the economic recovery and Canadian equities tend to perform much better in a more inflationary environment. However, as I highlighted in this month’s newsletter, higher rates and a rising US greenback globally may initially result in lower commodity prices. Over the mid to long term commodity prices will resume their uptrend with inflation rising at a fast clip causing real interest rates to remain negative for longer.
I remain overweight my new North American benchmark Financials, Energy, Materials, Industrials, Consumer Discretionary and Real Estate. I remain underweight Consumer Staples, Healthcare, Technology.
I am now going to underweight Communications with a recent slowdown in online advertising combined with ongoing regulatory government pressure.
I remain market weight Utilities.
Individual Equity Changes
In a portfolio blog dated July 27, 2021, I recommended a switch out of BMO’s Emerging Market ETF ZEM Cdn. $ to iShares Emerging Market ex China EMXC US $. Communist China’s ongoing restrictions on its domestic educational and IT companies is leading to a great deal of market volatility. The iShares Emerging Market ETF EMXC offers exposure to Emerging Markets but excludes the volatile Chinese companies.
Resulting from the very strong outperformance of Perkin Elmer, I am deleting it from my model growth portfolio in the Healthcare sector. EPS growth is expected to slow from current levels over the next few years.
Lastly in the Consumer Discretionary sector, I am adding Amazon’s Canadian Depository receipt to the growth portfolio. The symbol is AMZN. NE. CIBC has created exposure to some large high- tech companies that trade at very high per share levels. These Canadian receipts enable the investor to purchase fractional shares in Amazon and others, while simultaneously hedging the foreign exchange risk. While they may not trade exactly in the same proportion to its underlying US shares, they provides small investors with an opportunity to participate in a fast growing group of US sectors in IT and Communications.
Peter McMurtry, B.Com, CFA
Financial Writer, Objective Investment Advice for Everyone, Monthly Investment Newsletter and Sample Portfolios, Personalized Portfolio Reviews