Also available in PDF: McMurtry Investment Report Portfolio – March 2022
Investment Commentary March 2022
US Yield Curve
The ten minus two-year US Treasury yield curve narrowed very sharply by 38 basis points to 0.24%. This flattening of the curve is of concern as all previous recessions have been led by a negative yield curve where short rates exceeded longer maturities. However, this recent narrowing has transpired with the Russian invasion of Ukraine leading to a flight to US Treasuries. This factor combined with ongoing Federal Reserve purchasing of 10 year US Treasuries, has kept 10 year Treasury prices elevated and corresponding yields low. Despite this narrowing of the yield curve, I still feel that these afore-mentioned circumstances appear to make the probability of an upcoming recession seem greater than it really is. Once the Federal Reserve finally ends their Quantitative Easing Program shortly, yields on 10 -year US Treasuries will stop going down and will begin to rise again.
US Corporate Debt Spreads
As of March 3, 2022, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually rose modestly by 32 basis points to the current level of 2.24%. This minor rise in the corporate spread is nothing to worry about at this time when one takes into account where spreads normally rise to just before a recession.
Covid – 19 Health Stats
It seems that the spread of Covid-19 appears to be peaking in the western world with some exceptions like South Africa. The combination of lockdowns, widespread vaccinations, and herd immunity are getting this terrible pandemic in control.
Equity Market Valuations
The forward PE multiple of the S&P 500 is 19.20 as of March 4th. This compares to the long -term median of 19.6 times.
Central Bank Monetary Policy
Faced with rising inflationary pressures, the US Federal Reserve Bank remains vigilant in fighting inflation by reducing the balance sheet and increasing interest rates.
As a result of a hawkish Federal Reserve Bank, much less stimulative fiscal policy, very high inflationary pressures and rising geopolitical risk, I am increasing the cash weight to 25% for both portfolios. In a portfolio blog dated February 10th, I increased the cash weight by 2.5% to 22.5% for both portfolios and now I am increasing it by an additional 2.5%.
In my February 10th blog, I reduced the US Tip weight by 3.5% to 2%. In addition, I increased the Canadian preferred weight by 1% to 6% for both portfolios.
I am adding a 3% weight in Canadian 1 year GIC’s of EQ Bank online. The rate is 2.10%. I am reducing the 1-5 year corporate bond ladder ETFs by 3.00% and 3.5% for the Income and Growth portfolios respectively. In a rising interest rate environment, GIC prices will perform much better than regular bonds.
I am reducing my equity exposure by 2% for both portfolios to a level of 50% and 60% respectively. Furthermore, I am reducing my European and Emerging Market weight by 1% for both portfolios. Both Europe and Emerging Markets face a high level of uncertainty from the consequences of the Russian invasion.
All these above changes are recommended to reduce overall risk, but also to provide some cash should markets continue to decline. Having some cash in a short- term market correction can be advantageous when opportunities present themselves.
Equity Sector Weights
I remain overweight my North American benchmark Financials, Energy, Materials, Industrials, Consumer Discretionary and Real Estate. I remain underweight Consumer Staples, Healthcare, Technology, Utilities and Communications. The change in my North American benchmark domestic equity exposure to 70% Canada and 30% US will result in an additional overweight to the cyclical sectors of the market.
Individual Equity Changes
In a blog dated February 20th, I added AstraZeneca to both portfolios in the Healthcare sector. This drug producer offers a well diversified drug offering with its top selling drug only representing 13% of total revenues. The company has 12 blockbuster drugs with sales totalling $10 billion. Company management expect EPS to grow this year at a rate of 20% plus.
In a blog dated February 17th, I recommended a switch from TC Energy into Keyera for both portfolios. The company is trading at a much lower valuation while its EBITDA is expected to grow at the same rate as TC Energy.
In a blog dated March 3rd, I recommended a switch out of Citigroup into Bank of America for both portfolios in the Financials sector. Citi has a sizeable loan portfolio in Russia of $10 billion that may have to be partially written off. Bank of America offers a more solid and consistent earnings growth trajectory and is a major beneficiary of rising interest rates.
In the Energy sector I recommend a switch out of Suncor into Cenovus. The latter company offers considerably more upside than Suncor with its very strong cash flow leading to additional stock buybacks and dividend increases.
I am recommending the addition of Baytex Energy to the Growth portfolio in the Energy sector. Baytex is currently trading at a very attractive Enterprise Value to Forward EBITDA of 4.6 times and has a very healthy balance sheet with Financial Debt at only 0.71 times Trailing 12 months EBITDA. The company is currently trading at a free cash flow yield of 11.76%. Baytex is both a light and heavy oil producer and is expected to generate free cash flow this year of $550 million. In 2022 the company plans to allocate 25% of their free cash flow to their stock buyback program and the remaining 75% to paying down their debt levels.
Lastly in the Industrial sector, I am deleting Aecon from both portfolios and recommend the funds be redirected into both WSP Global and Stantec. Aecon’s projected growth rate continues to be hampered by Covid related issues in regards to the Bermuda Airport concession. Both Stantec and WSP offer better and more consistent growth prospects.
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