McMurtry Investment Report & Model Portfolios

McMurtry Investment Report Portfolios July 2022

Also available in PDF: McMurtry Investment Report Portfolio – July 2022


Investment Commentary July 2022

US Yield Curve

The 10-2-year US Treasury yield curve narrowed sharply from last month’s 0.32% to the current level of 0.06%. This is a material change and does indicate the probability of an upcoming recession is increasing.  Ten-year bond yields actually dropped from last month, an interesting development in the midst of Central Bank tightening.

US Corporate Debt Spreads

As of June 30, 2022, Baa rated US corporate bond spreads relative to 10-year US Treasuries were virtually the same as last month at 2.24%, compared to 2.26% last month.

Covid – 19 Health Stats

 Covid cases in North America are gradually improving and this is resulting in the removal of most lockdowns. Even in China the situation is improving.

Equity Market Valuations

 The forward PE multiple of the S&P 500 has declined sharply from 17.5 times last month to the current 16.1 times.

Central Bank Monetary Policy

 The US Federal Reserve remains absolutely vigilant in their quest to lower the rate of inflation. In this end, interest rates are expected to continue rising until the expected rate of inflation begins to ease. As I mentioned in my newsletter, there are some signs of a peaking in inflation, but it is still too early to call at this time.

Asset Mix

Interest rates have risen sufficiently recently and now provide some competition to dividend paying stocks. Over the next few months, it is expected that the rate of inflation will peak based on the less accommodative monetary and fiscal policies. Evidence of this can be seen from the recent peaking in most commodity prices, with the exception of crude oil that is only off marginally from its recent high. Copper prices are off about 25% from their recent highs and this metal is considered a gauge of the strength of the industrial sector of the global economy. In the US the popularity of Biden is being negatively affected by the rapid rise in US domestic inflation. This is another reason why interest rates will continue to rise to give an opportunity for the Democrats to improve their popularity in the polls. A mid term election is happening in the fall of this year and a lot can happen over the next few months.

The probability of a US recession is rising sharply with many economists putting a 50% probability of this happening over the next six months. Earlier in the year most investors were worried about high inflation with no growth or stagflation as it is called. However, the current expectation is for a peaking in inflation over the next several months from the very restrictive monetary policy. The fear now is for another recession within the next six months.

Historically in a period of stagflation, commodity and cyclical stocks tend to outperform the rest of the market. However, in a recession these groups tend to underperform the rest of the market.

Consequently, I am making some changes to both my recommended asset mix and to the individual equity sectors.

In regards to the overall asset mix changes, I am reducing the cash weight by 5% for both portfolios with all the proceeds being directed back into fixed income. I am not making any changes to my equity weight with a possible recession on the immediate horizon. Taking into account the average decline in US equity prices over the last several recessions is about 30%, the recent 21% decline in the S&P 500 index implies that about two thirds of the equity decline is probably behind us.

I am increasing the 1–3-year Canada corporate investment grade bonds with yields now approaching 4%.   I am also reducing the preferred weight by 1% with a peaking of interest rates not that far away. As I have highlighted many times in previous emails, you do not want to own preferreds in a period of falling rates. We are getting closer to this occurring, but not quite yet.

I am making a material change to my North American benchmark exposure. Last month I was at 75% Canada and 25% US. I am now changing this percentage to 65% Canada and 35% US with a possible recession looming.

Equity Sector Weights

Based on a looming economic recession I am making quite a few equity sector changes to better protect the portfolio in an economic downturn.

I am reducing the financial weight from overweight to underweight based on what has happened historically to bank stocks in previous recessions.

On this same train of thought, I am reducing the Consumer Discretionary and Reit sectors from overweight to underweight.

I am reducing the Materials weight from overweight to Market Weight. I am not reducing this group to underweight at this time as it comprises both precious metals, base, agricultural and industrial metals. However, I advise maintaining most of the exposure to this equity sector to the gold stocks. Gold and gold shares outperformed the overall US market in the recession of 2008.

I am maintaining my underweight in both Technology and Communications.

In the Industrials sector I am switching from overweight to market weight with this sector very sensitive to economic activity.

Higher interest rates put a lot of pressure on the consumer and this is why I am reducing the Consumer Discretionary weight from overweight to underweight.

I am increasing the Utilities and Consumer Staples sectors from underweight to overweight in the midst of a slowing economy.

I am increasing the Healthcare weight from market weight to overweight with this sector sharply outperforming the overall market in previous recessions.

Lastly, I have decided to maintain my overweight exposure to the Energy sector at this time. Differing quite markedly from the fundamental supply / demand outlook for base and industrial metals, the situation is much more favourable for the Energy stocks. While an end to the Russian / Ukraine war would probably cause crude prices to fall by about 10% from current levels, there is very little supply on the immediate horizon. As long as demand keeps up, crude oil prices will remain elevated. It should also be worth mentioning that a resumption of the Chinese economy will most definitely increase demand for crude oil.

Individual Equity Changes

In a blog dated June 27th, I added the US grocer, Kroger to both portfolios in the Consumer Staples sector.  Defensive stocks like this tend to do well in an economic downturn. Kroger has kept a tight lid on their operating costs with its vertically integrated network of dairy farms and its ownership of its transportation fleet. The company has a solid balance sheet and is steadily growing its operating cash flow.

In a recent blog I recommended a switch out of Premium Brands into Jamieson Wellness, in the Consumer Staples sector. The former company has been experiencing operating margin pressure, while this has not been the case for Jamieson. Jamieson has recently made a major US acquisition and this will provide it with a new platform in the US to expand its array of vitamins and natural health products.

In a recent blog, I added Apple to both portfolios in the Technology sector.  Higher interest rates have resulted in growth stocks like Apple experiencing sharp share price declines. The company is currently trading at 22 times this year’s EPS, at the lower end of its five- year range. The company has an unusually strong balance sheet. For the last 12 months, Apple has generated free cash flow of $107.79 billion, of which it has used $85.76 billion to buy back its own stocks. The company continues to generate strong services revenue principally from its Apps.

As a result of some significant new issues with Micron’s revenue outlook for both PC’s and iPhones, a potential recession will not be good for the company’s very cyclical earnings and cash flow. Consequently. I am deleting Micron from the Growth portfolio in the Technology sector.

Lastly, I recently added the Canadian oil producer, Enerplus to both portfolios. The company is a large generator of free cash flow and is exhibiting very strong growth in EBITDA in this period of high crude prices. The shares remain cheap on an Enterprise Value to Forward EBITDA basis at 3.45 times. In addition, the company has a strong balance sheet. Over the next few quarters, the company has announced its intention of using 50% of its free cash flow to buy back stock, reduce its debt even further and make additional acquisitions. Assuming crude prices remain at current levels, the company expects to be debt free by the second quarter of next year.

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Also available in PDF: MIR Portfolios April 2019

Investment Commentary (April 2019)

Asset Mix Changes

Last week both the Canadian and US yield curve inverted where short rates exceeded longer maturities. For most of the past economic recessions, an inverted yield curve occurred 6-18 months before the onslaught of an economic slowdown. Consequently, this signal should not be taken lightly and brushed off as is frequently the case with economists stating that things are different this time.

This week the inversion of the curve went away in both Canada and the US with longer rates now slightly exceeding shorter maturities. However, the negative yield curve is still present in Europe where their economy continues to suffer.

US corporate bond spreads for both investment and High Yield securities had been creeping up in late December. However, year to date corporate spreads over US Treasuries have been coming down once again. Historically when corporate spreads widen this is a danger signal for an economic slowdown. The recent reduction is spreads is a positive sign that the economy may not be as weak as many pundits are saying.

Overall economic activity is definitely slowing globally. This is also true in the US but their economy is still growing on a relative basis much faster than Europe and Canada. Economic growth in the Chinese economy had been coming down sharply, but this week an announcement came out stating that their domestic industrial production started to revive after nearly nine months of decline. Several months ago the Chinese authorities began stimulating their domestic economy by lowering corporate taxes and increasing government spending. Once again this is a positive development.

The Federal Reserve has stopped increasing rates by emphatically stating that there will be no more rate increases for the remainder of the year.

US corporate profit growth has slowed dramatically from last year, while equity prices have rebounded sharply year to date. Equity valuations are no longer cheap as they were in late December.

This week the US / China trade talks have taken a more positive tone which is good for markets.

Taking all these factors into consideration, I have decided to leave the asset mix for both portfolios the same as last month. The jury is still out if an economic recession is imminent or only years away.

McMurtry Investment Report Asset Mix (April 2019)
Asset Mix – Income and Growth Portfolios
%Income Growth
Bonds – Regular20.0010.00
Bonds – High Yield5.005.00
Emerging Markets0.000.00

Equity Sectors

The main change to my equity sector recommendations is to reduce the Financial equity exposure from overweight to market weight the 55% US 45% Canada benchmark. This works out to a new weight of 21.25% of my North American equity exposure.

The reason for my reduction in weight for the Financial sector is all to do with interest rates and the slope of the yield curve. Lower rates combined with either a flat or inverted yield curve is not positive for the bank’s net interest margins. A slowing economy normally results in an increase in loan losses, another possible headwind.

For the other groups I remain market weight Energy, Utilities and Healthcare.

I remain overweight Technology, Industrials, Real Estate, Communication Services and Consumer Staples

I remain underweight Materials and Consumer Discretionary.

McMurtry Investment Report – Sector Weights (April 2019)
Equity Sector Weights (%)
SectorMy WeightTSX CompS&P 50055 % US /45% CDN
Consumer Disc.6.404.1010.107.40
Comm. Services8.505.8010.108.17
Consumer Staples6.253.907.305.77
Real Estate3.753.503.103.28

Common Equity Changes

In the Financial Services sector, I am replacing National Bank with Intact Financial for both portfolios. Intact is the largest property / casualty company in Canada and will benefit from the recent departure of AIG, a large US competitor from the Canadian market. Intact is raising insurance rates in Ontario and this will help to increase operating margins. Differing from life insurance companies, property and casualty insurance companies have much shorter term liabilities and are consequently not as negatively affected from flat to falling interest rates as the life companies are.

In the Technology sector, I am deleting Nokia from both portfolios. Huawei, the Chinese company and major competitor to Nokia has been continuously lobbying the global wireless providers to encourage them to continue buying their products. It is only in the US that the Chinese company has been banned with its alleged cybersecurity activities. Thus, Nokia has not been as much of a beneficiary from the 5G wireless ramp up as originally expected. In addition, a law firm has recently alleged that Nokia’s Alcatel – Lucent division has some very serious potential claims for security law violations. This creates a lot of uncertainty. My recommendation is to sell your Nokia shares and use the proceeds to purchase more Cisco, which will be a major beneficiary from the upcoming 5G implementation.

In the healthcare sector I am adding the Swiss dental implant company, Straumann Holdings ADR to my Growth portfolio. This American Depositary Receipt is not very liquid in the US market, so please always use limit orders when buying and selling this security. Despite this shortfall, this is a good quality company and one of the global leaders in the dental implant industry. The company is experiencing strong annual revenue and gross profit growth in addition to record EBITDA margins. The company has strong organic growth and operates in 100 countries globally. The global dental implant market is expected to grow at 4-5% globally this year and Straumann’s organic growth is sharply outperforming its competitors.

Lastly in the Materials sector, I am adding Osisko Metals to my Growth portfolio. The company is a small cap zinc exploration company that operates in both the Far North and in New Brunswick. The company has no long term debt and the level of insider buying is unusually high. Normally I do not even discuss insider buying, but the level of insider buying for this company is extraordinary. The supply / demand situation for zinc is the most favourable for all the base metals with inventory stockpiles at very low levels. Should the Chinese economy rebound the demand for zinc will increase accordingly.

Peter McMurtry, B.Com, CFA
Financial Writer
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McMurtry Investment Report – Portfolios (April 2019)
CashAlterna Bank – High Interest Savings (2.35% current rate)Alterna Bank – High Interest Savings (2.35% current rate)
 EQ Bank – High Interest Savings ( 2.30% current rate)EQ Bank – High Interest Savings ( 2.30% current rate)
Bonds -RegulariShares XSB Short TermiShares XSB Short Term
 iShares CBO 1-5 Ladder CorpiShares CBO 1-5 Ladder Corp
 iShares CLF 1-5 Ladder Gov’tiShares CLF 1-5 Ladder Gov’t
Bonds – High Yield CORPiShares XHY US High Yield CDN$  iShares XHY US High Yield CDN $ 
Common StocksSecurityDividend Yield %SecurityDividend Yield %
FinancialsRoyal Bank RY4.05Royal Bank RY4.05
 Bank of Montreal BMO4.00Bank of Montreal BMO4.00
 Bank of Nova Scotia BNS4.89Bank of Nova Scotia BNS4.89
 Intact Financial IFC2.69Intact Financial IFC2.69
 TD TD4.08TD TD4.08
 Sun Life SLF3.90Sun Life SLF3.90
 JP Morgan JPM US3.16JP Morgan JPM US3.16
 Bank of America BAC US2.17Bank of America BAC US2.17
 Citibank C US2.89Citibank C US2.89
 Morgan Stanley MS US2.84Morgan Stanley MS US2.84
 T. Rowe Price TROW US3.04T. Rowe Price TROW US3.04
 Keycorp KEY US4.32Keycorp KEY US4.32
 PNC Fin’l PNC US3.10PNC Fin’l PNC US3.10
EnergySuncor SU3.85Suncor SU3.85
 Freehold FRU7.43Freehold FRU7.43
 Torc TOG5.62Torc TOG5.62
 Pembina Pipe Lines PPL4.55Pembina Pipe Lines PPL4.55
 Enbridge ENB6.04Enbridge ENB6.04
 Trans Canada TRP4.91Trans Canada TRP4.91
   Parex Resources PXT0.00
MaterialsAgnico Eagle AEM1.15Agnico Eagle AEM1.15
 Franco Nevada FNV1.29Franco Nevada FNV1.29
   Osisko Metals OM.V0.00
   iShares Global Gold ETF XGD0.20
IndustrialsToromont TIH1.55Toromont TIH1.55
 Air Products APD US2.44Air Products APD US2.44
 WSP Global WSP2.06WSP Global WSP2.06
 Canadian Pacific CP0.94Canadian Pacific CP0.94
 CNR 1.79CNR1.79
 Raytheon RTN US2.03Raytheon RTN US2.03
 Aecon Group ARE3.33Aecon Group ARE3.33
 Guggenheim Eq WT IND RGI US1.35Guggenheim Eq Wt IND RGI US1.35
 Honeywell HON US2.07Honeywell HON US2.07
 TFI Int’l TFII2.45TFI Int’l TFII2.45
Consumer DiscretionaryHome Depot HD US2.80Home Depot HD US2.80
 Sleep Canada ZZZ3.77Sleep Canada ZZZ3.77
 Canadian Tire CTC.A2.88Canadian Tire CTC.A2.88
 Amazon AMZN US0.00Amazon AMZN US0.00
 Lowes LOW US1.75Lowes LOW US1.75
Communication ServicesRogers B RCI.B2.78Rogers B RCI.B2.78
   Facebook FB US0.00
   Alphabet GOOGL US0.00
Consumer StaplesAlimentation Couche- Tard ATD.B0.64Alimentation Couche Tard ATD.b0.64
 Loblaws L1.79Loblaws L1.79
 Constellation Brands STZ US1.69Constellation Brands STZ US1.69
 Unilever PLC UL US3.06Unilever PLC UL US3.06
TechnologyApple AAPL US1.54Apple AAPL US1.54
 Microsoft MSFT US1.56Microsoft MSFT US1.56
 Open Text OTEX1.58Open Text OTEX1.58
 Paychex PAYX US2.79Paychex PAYX US2.79
 Cisco CSCO US2.59Cisco CSCO US2.59
   Kinaxis KXS0.00
   ETFMG Prime Cyber Sec. HACK US0.15
   Visa V US0.64
UtilitiesAlgonquin Power AQN4.58Algonquin Power AQN4.58
 Northland Power NPI5.12Northland Power NPI5.12
 Fortis FTS3.64Fortis FTS3.64
HealthcareAbbott Labs ABT US1.60Abbott Labs ABT US1.60
 Becton Dickinson BDX US1.23Becton Dickinson BDX US1.23
 Merck MRK US2.65Merck MRK US2.65
 US Healthcare iShares ETF IYH US1.84US Healthcare iShares ETF IYH US1.84
 United Healthcare UNH US1.46United Healthcare UNH US1.46
   Danaher DHR US0.52
   Thermo Fisher Scientific TMO US0.28
   Straumann ADR SAUHY US *0.63
   IBB Biotech ETF IBB US 0.28
Real EstateCdn Apt. REIT CAR.un2.76Cdn. Apt. REIT CAR.un2.76
 InterRent REIT IIP.un2.03InterRent REIT IIP.un2.03
 Dream Industrial DIR.un5.83Dream Industrial DIR.un5.83
 Summit REIT SMU.un4.35Summit REIT SMU.un4.35
European EquityiShares MSCI Europe XEU2.96iShares MSCI Europe XEU2.96

* Be careful purchasing and selling Straumann ADR’s as it is very illiquid. Always use a limit order.

Peter McMurtry, B.Com, CFA

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