Investment Commentary March 2021
US Yield Curve
The ten minus two- year US Treasury yield curve jumped to 1.42% as of March 5, 2021 from 0.80% at the end of December of last year. This is positive for the economy. In particular the ten- year US treasury yield has risen to 1.56 % from 0.93% at Dec 31st.
US Corporate Debt Spreads
As of March 4th, Aaa rated US corporate bond spreads relative to 10-year US Treasuries backed up to 1.46%, from the December 31st level of 1.30%. On the other hand, the Baa rated US corporate bond yield spreads, at 2.13% as of March 4th, are lower than what they were at the year end’s level of 2.18%. High Yield spreads declined to 3.54% as of March 4th compared to 3.86% at year end. 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.
US / China Trade Issues
Joe Biden and the Democrats are expected to be more conciliatory with China, although it is too early to tell at this point.
Covid – 19 Health Stats
The number of new cases in the US is starting to see a material decline as the percentage of the population getting a Covid-19 vaccine continues to increase.
Equity Market Valuations
The Forward PE of the S&P 500 is still inflated at 21.5 times. This compares to the long -term median of 19.6 times.
US Domestic Economic Growth
The US economy is expected to see a sharp rebound in the second half of this year propelled by another stimulus package and much better news on the percentage of the population being vaccinated. Employment growth for February continued to show a dramatic improvement. 4th quarter US quarterly earnings registered a V-shaped recovery with most companies delivering better numbers than consensus.
Central Bank Monetary Policy
Governor Powell and the US Federal Reserve Bank expect a short- term acceleration in domestic inflation as the economy rebounds. He was pressured by the media to address the recent increase in nominal and real interest rates. 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.
Despite the soothing rhetoric by Governor Powell, nominal interest rates are really starting to rise across all maturities. Although real interest rates remain negative, they are becoming less negative for the 7-, 10- and 20-year maturities. At some level of nominal rates, the stock market will become more concerned and may experience a short- term correction of up to 10%. However, taking into consideration the new stimulus package and the economy’s enormous pent -up demand, equity markets are likely to take higher rates in stride. I would use any market correction as a buying opportunity.
I am reducing the Regular Investment Grade bond weight by 3% for both portfolios. At the same time, I am increasing the High Yield weight for both portfolios by 2% to 10% and increasing the cash exposure by 1% to 15% for both portfolios.
Equity Sector Weights
Propelled by higher rates, a three-month high for the US Dollar globally, a rebounding economy and a major equity sector rotation from growth into cyclical stocks, I am making several changes from last month.
I am reducing my Technology weight from market weight to underweight. I am reducing my REIT exposure from overweight to underweight. I am reducing my Utilities exposure from overweight to market weight. I remain overweight Financials and Industrials but am increasing my overweight. I remain underweight Communications, but am reducing my underweight as explained in my recent newsletter. I am increasing my overweight in Energy but decreasing my overweight in Materials. More specifically, gold is experiencing a lot of headwinds currently from the combination of a US dollar beginning to rise once again and rising nominal and real interest rates. As gold is not an industrial metal, its price is more susceptible to rising rates and a stronger US dollar. The rising real interest rates, turning less negative, are also a real headwind for gold. My advice is to reduce your exposure to gold and gold shares but to continue to hold a small position. The Materials sector includes base metals, fertilizers and industrial gases that have more upside in an improving economy than gold. As mentioned previously, silver faces less headwinds than gold as it is an industrial metal and a beneficiary of an increase in demand from renewable energy and the electrification of cars.
I am increasing my underweight in Consumer Staples and reducing my overweight in Consumer Discretionary.
I am keeping my market weight in Healthcare.
Individual Equity Changes
In a portfolio blog dated February 16th, I added Pembina Pipelines to both portfolios. Despite the sharp increase in 4th quarter write-downs that included a suspension of the proposed petrochemical facility, the volume of business is trending higher and the company has good operating leverage to rising throughput. The company pays a dividend of 6.96% and offers a free cash flow yield of over 6%.
In a blog dated March 3rd, I added Dover Corp to both portfolios. The company is a US manufacturer of industrial and aerospace products, petroleum and engineering products and refrigeration and food equipment. The company is a strong generator of both operating and free cash flow that offers a free cash flow yield of 4.97%. It offers a dividend yield of 1.52% that is well covered.
In the healthcare sector, I am adding the US private healthcare provider, Anthem, to both portfolios. The company is more much attractively valued than United HealthCare with a Forward PE of only 13.53 times compared to over 19 times for United HealthCare. Anthem offers a dividend yield of 1.35% and a free cash flow yield of 11.13%. The company is growing its EPS nicely and offers good upside opportunities.
In the Technology sector, I am adding Oracle to both portfolios. It offers a dividend yield of 1.37% that is well covered by cash flow. It is also trading at a much lower PE multiple than many of its peers at 16 times this year’s earnings. While its EPS projected growth rates are lower than its peers, it is still expected to grow its EPS this year at over 13%. In addition, its recent success in the cloud may very well result in the company’s growth rates in EPS expanding more than is currently anticipated.
Lastly, I am adding the Mosaic Company to the Growth portfolio. It is a major US producer of both phosphate and potash fertilizers. It offers a dividend yield of 0.67% that is well covered by cash flow. The shares are currently trading at a reasonable 6.7 times EV/ Forward EBITDA. Its financial debt is under 4 times trailing twelve- month EBITDA.
Peter McMurtry, B.Com, CFA
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