Also available in PDF: McMurtry Investment Report Portfolio – July 2021
Investment Commentary July 2021
US Yield Curve
The ten minus two- year US Treasury yield curve fell modestly to 1.23% compared to 1.46% at the end of May of this year. The recent flattening of the yield curve can be explained by the rise in 2- year yields combined with a decline in the 10- year maturities. As the yield curve remains positive, this is not something to be concerned about in regards to the domestic US economy.
US Corporate Debt Spreads
As of July 1st, 2021, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually narrowed by ten basis points to 1.86%. The High Yield spreads also exhibited the same trend by shrinking by 26 basis points to 3.02%. This is positive for the US economy and indicates that the probability of the US dipping into another recession at this point is low.
Covid – 19 Health Stats
The vaccine rollouts in both Canada and the US are going remarkably well. The rest of the world is seeing a more gradual improvement than North America, but nevertheless an improvement. It is anticipated that any variants will be well controlled in North America and only result in a limited amount of new outbreaks of Covid-19 in specific locations.
Equity Market Valuations
The Forward PE of the S&P 500 remains inflated at 21.3 times. This compares to the long -term median of 19.6 times. The principal reason this valuation measure has not risen as the equity markets have is solely due to the very strong earnings growth.
US Domestic Economic Growth
The US added a better than expected 850,000 jobs in June. US domestic inflation remains quite inflated with strong year over year growth in air fares, hotels, new and used cars and food and energy. A material chunk of this recent price rise can be explained by the reopening of the economy and businesses charging higher prices for cars, air fares and hotels. These items may end up being transitory, but the strength in wages may not be so short term in nature. We all know there is a labour shortage currently with employees having the upper hand for the first time in many years. It will be very important to see what the trend in wages will be after the government handouts stop.
Central Bank Monetary Policy
Governor Powell and the US Federal Reserve Bank expect a short- term acceleration in domestic inflation as the economy rebounds. However, the Federal Reserve do not want to alter their current accommodative monetary policy just yet and expect to continue with their government bond tapering program.
Asset Mix
In a portfolio blog dated June 16th, I reduced equities by 8% with a corresponding increase of the same amount in cash to 23%. Now I am reducing the cash weight for both portfolios back down to 20% with a new 2% weight in Canadian preferreds and a 1% increase in European equities. European equities offer good relative value while rate reset preferreds will perform well in a period of rising interest rates. You all know by now my dislike of rate reset preferreds as they are very illiquid and perform very poorly when rates go down. However, the immediate outlook for interest rates is to see them begin to climb back up once again from current levels. I recommend the Horizons actively managed preferred ETF, HPR.
Equity Sector Weights
I remain overweight my 60% Canada 40% US North American benchmark weight the following sectors: Financials, Industrials, Energy, Materials and Consumer Discretionary. I remain underweight Consumer Staples, Healthcare and Technology but have reduced my Technology underweight somewhat from last month.I am maintaining my market weight in Communications and Utilities. Lastly, I am increasing my Reit sector exposure to overweight from market weight last month. This sector is experiencing a sharp rebound and the outlook for industrial and apartment Reits remains favourable.
Individual Equity Changes
In the Healthcare sector, I added Medtronic to both portfolios in a portfolio blog on June 16th . This medical device company offers a reasonable valuation, a dividend yield close to 2%, a strong balance sheet and projected long term EPS growth of at least 9-10% annually. More specifically in the diabetes monitoring area, the company is now offering a complete glucose monitoring system in Europe and has applied for approval in the US.
In a portfolio blog dated June 21st, I added Premium Brands to both portfolios in the Consumer Staples area. The company offers a dividend yield of over 2% that is well covered by operating cash flow. The company is expected to see strong EPS growth over the next several years and has already experienced 6-8% average annual organic sales growth.
Lastly in a portfolio blog dated June 29 th I added Sleep Country to both portfolios in the Consumer Discretionary sector. The company offers a dividend yield of 2.62% that is very well covered by operating cash flow. In addition, the company has a strong balance sheet that has enabled it to increase its warehouse capacity by 65%. The company is expected to register solid EPS growth this year and next.
Peter McMurtry, B.Com, CFA
Financial Writer, Objective Investment Advice for Everyone, Monthly Investment Newsletter and Sample Portfolios, Personalized Portfolio Reviews
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