Also available in PDF: McMurtry Investment Report Portfolio – December 2022
Investment Commentary December 2022
US Yield Curve
The inversion of the 10-2-year US Treasury yield curve is increasing from the negative 41 basis points on October 31 to the negative 77 basis points as of December 2nd. This implies that the probability of a recession in 2023 is increasing.
US Corporate Debt Spreads
Corporate debt spreads continue to widen to the December 1 level of 2.30%. However, these spreads are much lower than the 4.3% in 2020 or the 6% plus level in the recession of 2008. This may indicate the severity of the upcoming recession may be milder than in 2008.
Covid – 19 Health Stats
Covid cases and lockdowns continue to escalate in China. Major Chinese cities are almost totally locked down. It is quite obvious to me that the Communist government has been hiding a lot of the negative stats on Covid for the last several years in order to save face. Now that it has gotten totally out of hand, they have no choice but to respond. There have been several large protests in China with citizens justifiably wondering why the lockdowns continue with the rest of the world ending most lockdowns. It is quite obvious to me that the Communist Party incorrectly opted for a locally made vaccination rather than relying on either Pfizer’s or Moderna’s more proven vaccinations. All of this has led to a sharp growth slowdown in China affecting the demand for many commodities and ultimately reducing the level of global economic growth. No one knows for sure how long these lockdowns will continue, but should China opt to change vaccination suppliers to either Pfizer or Moderna, the situation will immediately improve.
Equity Market Valuations
The forward PE of the S& P 500 has risen from 16 times last month to 17.7 times as of December 2nd. This is totally a result of equity prices rebounding with earnings projections continuing to decline.
Central Bank Monetary Policy
Chairman Powell recently indicated that the rate of future interest rate increases will most likely be lower than was the case for this year. However, he did not imply that rates will back off materially anytime soon.
Asset Mix
I am reducing cash by 10% for both portfolios with the proceeds being redirected into 5% more equities and 7% into domestic investment grade corporate bonds with a maturity up to three years. 2% is being added back to cash with the sale of the position in floating rate bonds.
Short term ( 1-3 year) Investment grade corporate bonds are yielding anywhere from 4-5% depending on the maturity and the credit. This is the best yields offered in some time from this asset class and warrants an increase in weight. I am still recommending a 1-5 year Government of Canada bond ladder, but have replaced the 1-5 year corporate bond ladder with the 1-3 year investment grade bonds.
I am not increasing the GIC weight beyond last month’s 5% for either portfolio and continue to only advise a one- year term.
The potential peaking in inflation and interest rates is also helping the equity market. At 40% and 50% for the Income and Growth portfolios, my position on equities is becoming more favourable, but is still neutral overall. Normally in a bull market my percentage of equities would be much higher.
Equity Sector Weights
I remain overweight my North American benchmark Energy, Healthcare, Consumer Staples and Utilities.
I remain underweight Technology, Financials, Industrials and Consumer Discretionary.
I remain market weight Reits and Communications.
My major change this month is to go from an underweight position in Materials to market weight. The main reason for this change is that US interest rates and inflation may be peaking shortly. This will eventually lead to a peaking in the US dollar globally as well. Lower interest rates and a falling US dollar are both good for commodity prices, especially base metals and gold. In addition, the recent collapse in a bitcoin exchange has caused a major decline in cryptocurrency investments. Bitcoin had been viewed by many investors as an alternative to gold and now this group may go back into gold investments instead.
Individual Equity Changes
In a recent blog dated November 30th, I added the US global provider of data centers, Equinix, EQIX US to both portfolios in the Reit sector. Currently the company has 240 data centers in 66 markets worldwide and is planning on more next year. The current dividend of 1.79% is well covered with a funds from operations payout ratio of 45%. While the stock is not cheap at 24 times trailing 12- month funds from operations, it is reasonable taking into account the growth projections. The 3rd quarter saw revenues, gross profit and funds from operations grow year over year by 10%, 15% and 20% respectively. Equinix’s financial position is enhanced by its 8.6 year average term on its debt and its blended borrowing rate of 1.96%.
In a portfolio blog dated November 11th, I recommended that investors sell half their positions in Algonquin Power from both portfolios in the Utilities sector and to invest the proceeds into Capital
Power. Algonquin has exhibited very poor financial performance recently and its financial debt as a percentage of trailing twelve- month EBITDA is at a very high 9.6 times. As a result of their consistent earnings and cash flows, many utilities can have much more debt than other companies in different industries normally have. However, in the case of Algonquin, this was not the case with their earnings and cash flows not being able to keep up with their debt obligations. At this point I recommend that you totally exit your position and redeploy your funds into other domestic utilities like Capital Power, Boralex, Northland Power, Brookfield Renewable, Brookfield Infrastructure and Fortis.
In a portfolio blog dated November 11th, I added Capital Power to both portfolios in the Utilities sector. Capital Power offers a solid dividend of 4.94% with a reasonable cash flow payout of 74%. The company has a strong balance sheet with financial debt representing 3.442 times trailing twelve- month EBITDA, much lower than Algonquin’s 9.6 times.
On November 7th there was an offer to purchase Summit Industrial Reit by the Singapore Wealth Fund and by Dream Industrial Reit at a price of $23.50 per share. I am leaving Summit on the list as the offer is 5% higher than the current share price.
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