Investment Commentary December 2021
US Yield Curve
The ten minus two- year US Treasury yield curve declined sharply by 32 basis points to 0.78%. The recent flattening of the curve must be closely monitored, but at this moment it still remains positively sloped and causing no immediate harm to economic growth.
US Corporate Debt Spreads
As of December 6th, 2021, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually widened modestly by ten basis points to 1.79%. This small increase is no indication that there is an upcoming recession.
Covid – 19 Health Stats
In the US the 7-day average of new Covid-19 cases has gone back up to 100,000. The 7 day daily new deaths have reached 1,000 once again. 60% of the US population has been double vaccinated while 86% over 65 have received two dosages. In Canada, 75% of the population has received two dosages of the vaccines. As you can see Canada is doing much better than the US. In the vaccine rollout. Globally, only 8% of low-income countries have been vaccinated with South Africa at 26%, still much lower than North America. In these low-income countries, it is not only an issue of affordability but also involves the logistics of distributing the vaccines available. Nigeria recently stated that over 1 million dosages of the vaccine available had to be thrown out before use as a result of the expiry of an acceptable time period to distribute the dosages. Globally the Delta variant remains the most prevalent, but the newly discovered Omicron variant is proving to be much more transmissible.
Equity Market Valuations
The forward PE multiple of the S&P 500 index fell marginally to 20.5 times as of December 5th of this year. This compares to the long -term median of 19.6 times.
Central Bank Monetary Policy
The US Federal Reserve has finally decided to increase its tapering program for new bond purchases. This is their first step in ending the massive Quantitative Easing Program whereby the Central Bank purchased large quantities of longer-term securities. Interest rates are now expected to begin rising once again and this will be most noticeable in shorter securities. Chairman Powell now realizes that the Central Bank has been behind the curve in letting domestic inflation run at much too high a level relative to their long-term projections. Taking into account the strength on the domestic US economy, there is no immediate cause for worry about a new recession on the horizon.
As a result of a more hawkish Federal Reserve and a highly transmissible new variant, Omicron, I am increasing my cash weight for both portfolios by 2%. I am also reducing my High Yield exposure by 2% for both portfolios in order to reduce portfolio volatility in the fixed income area. I am maintaining the same equity weight as last month, but am reducing both my European and Emerging Market equity weight by 1% each for both portfolios. Both Europe and Emerging Markets have their own unique market risks that are rearing their head at this time.
Equity Sector Weights
I remain overweight my North American benchmark Financials, Energy, Materials, Industrials, Consumer Discretionary and Real Estate. I remain underweight Consumer Staples, Healthcare, Technology, Utilities and Communications. I continue to favour cyclical industries over both growth and defensive ones with their pricing power helping them to pass on their raw material cost increases to their clients.
Individual Equity Changes
In a portfolio blog on November 22nd, I added Equinox Gold to the Growth portfolio in the Materials sector. The stock is trading at a reasonable valuation yet offers significant production growth projections over the next few years from its purchase last year of Premier Gold. The company has a strong balance sheet and offers good price leverage to rising gold prices.
In a portfolio blog dated November 22nd, I added Parkland Corp. to both portfolios in the Energy sector. It is positioned in the Energy sector with its ownership of an oil refinery in Burnaby, BC. However, its main business is gas stations and convenience stores and its main competitor is Alimentation Couche-Tard. The company trades at a more attractive valuation to Alimentation Couche-Tard on an Enterprise Value / Forward EBITDA multiple basis and is expected to grow its adjusted EBITDA next year at a rate of 16%. The company offers a dividend yield of 3.61% with a very manageable 55% cash payout ratio.
Lastly, I am deleting Merck from both portfolios in the Healthcare sector and adding Pfizer to both portfolios as a replacement. Merck is having some real issues with its drug pipeline in regards to its HIV franchise, while it trades on forward earnings per share at a comparable valuation to Pfizer. Pfizer’s earnings are expected to rise at a much faster clip than Merck next year propelled by its new Covid-19 vaccine, boosters, anti-virals and antibody treatments The company offers a dividend yield of over 3% and trades at a PE on forward earnings of 12.2 times.
Lastly in the Industrial sector I am deleting Fedex from both portfolios. The company is about to report their quarterly earnings this Thursday and their operating costs are rising through the roof. Rising labour and fuel costs combined with supply chain disruptions are negatively affecting operating margins and this trend is continuing from the last quarter. Over the last ninety days, consensus EPS has declined by almost 15%. While revenues are still on track, another disappointment in EPS as occurred last quarter, would not be well received by the equity market at this time when Covid-19 cases are increasing and more lockdowns are happening.
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