Investment Commentary June 2021
US Yield Curve
The ten minus two- year US Treasury yield fell modestly to 1.42% compared to 1.49% at the end of April of this year. This remains positive for the economy.
US Corporate Debt Spreads
As of June 3, 2021, Baa rated US corporate bond spreads relative to 10-year US Treasuries remained about the same as last month at 1.96%, as did High Yield spreads at 3.28%. Once again 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 rollout is going very well in the US and this is resulting in the number of daily cases levelling off. Domestically our vaccine rollout is also doing well and improving with more than 60% of the Canadian population having received at least one dose. The ongoing domestic lockdowns are definitely having a positive effect despite all the backlash from the business community.
Equity Market Valuations
The Forward PE of the S&P 500 is still 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 domestic economy remains strong with their economy opening up. However, this has resulted in a significant rise in US inflation that the Federal Reserve has tried to explain as only transitory. Mohamed Olirian, the famed economist, does not believe that the recent pickup in US inflation is temporary as it is based on continuing labour shortages, supply bottlenecks and strong commodity prices. At some point the US central Bank is going to be forced to raise interest rates to prevent inflation from rising to quickly. Once this happens equity markets will need to digest this information and will quite likely take a breather from their lofty levels. In the meantime, however, both US fiscal and monetary policies remain very accommodative. The risk is that inflation will rise much faster than anticipated and this will eventually be accompanied by higher rates.
Historically in a period of higher rates and higher inflation, cash and nominal fixed income investments tend not to perform very well. Inflation adjusted real return bonds, equities and commodities tend to perform much better.
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.
I am making several changes to the asset mix this month. Firstly, I am increasing my Canadian equity weight for the North American benchmark to 60% Canada and 40% US. This change is totally a result of improving commodity prices, a cyclical recovery in the global economy and a strong loonie relative to the US greenback. I am reducing High Yield bonds by 3% for both portfolios and adding a 3% weight in US Tips, symbol Tip US$ for both portfolios. Please keep in mind that I am only adding the US Tip Real Return bond ETF and not the Canadian XRB. This is because the US Tip ETF has a much shorter duration than the Canadian XRB and this is resulting in much better investment performance. While the current real yield on this ETF is a negative 1.4%, the total return over the last 12 months is 6.56%.
Equity Sector Weights
I remain overweight my newly revised 60% Canada 40% US North American benchmark weight the following sectors: Financials, Industrials, Energy, Materials and Consumer Discretionary. I am increasing my overweight in both Financials and Energy.
I remain underweight Consumer Staples and Technology and have materially increased my Technology underweight. I have also gone from market weight to underweight the Healthcare sector with stronger earnings growth coming from the cyclical sectors.
I am maintaining my market weight in Communications, Utilities and Reits.
Individual Equity Changes
In the Financial sector I added the European Financial ETF EUFN – US$ to both portfolios in a blog dated May 23rd. The fund offers a distribution yield of 1.14% and provides exposure to the European bank and insurance companies.
In a blog dated June 2, I recommended a switch out of Bank of Nova Scotia into CIBC for both portfolios. CIBC is showing strong revenue, loan and deposit growth while Scotia is not. CIBC offers a dividend yield of 4.15%.
In the Materials sector, I am deleting Hudbay Mining from the Growth portfolio. RBC estimates that their mine in Peru accounts for over 60% of the net asset value of the company. The general election in Peru is just to close to predict the final outcome, although it is very likely that Hudbay will be faced with increased royalties to the Peruvian government. Even after its recent decline Hudbay still trades at an EV/ Trailing twelve month EBITDA ratio of over 10 times, almost double what Capstone trades at. Using projected EBITDA, the ratios are more comparable between the two companies. However, the political risk does not warrant an investment in Hudbay at this time given its large exposure to Peru.
In a blog on May 17, I added Kirkland Lake Gold to both portfolios. The company has a solid balance sheet with zero long term debt and offers a dividend yield of 2.06%
In the Reit sector I am adding Tricon Residential to both portfolios. This Canadian Reit operates in the US sunbelt area and in Canada where it offers reasonable rents and solid growth prospects. It offers a dividend yield of 2.15% with a 76% cash flow payout ratio.
In addition, in the Reit sector, I wrote blogs on both Granite and Dream Industrial Reits to average down your holdings by buying more units after their recent equity issues.
In a blog dated May 26, I advised averaging down your holdings in Capital Power by buying more units after their recent equity issue.
Lastly in a blog dated June 4, I advised purchasing more shares of Osisko Metals after announcing some fundamental improvements to their water flow problems.