Also available in PDF: McMurtry Investment Report Portfolio – May 2022
Investment Commentary May 2022
US Yield Curve
The 10-2 year US Treasury yield curve turned positive to the current level of 0.19% as of April 29th, a reversal from last month’s negative 0.06%. The ending of the Federal Reserve’s ongoing bond purchases of longer term maturities and the announcement of the Central Bank’s liquidation of its balance sheet may be just starting to have an effect on the yields of the longer bonds with their yields getting closer to 3%. US domestic inflation is at the highest level in many years propelled by the continuation of goods supply shortages, rising labour costs and record high commodity prices.
US Corporate Debt Spreads
As of April 28, 2022, Baa rated US corporate bond spreads relative to 10-year US Treasuries rose modestly to 2.06% from last month’s 1.93%.
Covid – 19 Health Stats
As I expected the ending of lockdowns globally, with the exception of China, has resulted in a gradual increase in the number of daily cases. Fortunately most of these cases have mild symptoms, but nevertheless we are not totally out of the woods just yet. In regards to China, they are clearly experiencing some severe issues with this pandemic and this has propelled the government to dramatically increase lockdowns.
Equity Market Valuations
The forward PE multiple of the S&P 500 declined to the current level of 17.6 times from 19.60 last month..
Central Bank Monetary Policy
Faced with rising inflationary pressures, the US Federal Reserve Bank remains totally committed to controlling inflation by reducing the balance sheet and increasing interest rates.
The combination of ongoing geopolitical risk from the Ukraine war, a very hawkish Federal Reserve, less accommodative fiscal policy, sharply rising energy and commodity prices and a labour shortage is creating a great deal of uncertainty regarding the sustainability of this economic cycle.
Consequently, I am recommending an increase in my cash weight of 5% for both portfolios to a new level of 40%, with equities simultaneously being reduced by the same amount. In a previous blog late last month I increased the cash weight to 35% by reducing preferreds by 3% and by eliminating High Yield corporate bonds. The new 40% cash exposure will provide a nice cushion should either equity or bond prices fall further from current levels and help to substantially reduce portfolio volatility.
The jury is still out in terms of another economic recession. At the moment the likelihood has gone up to around 33%, but still not the most likely scenario of stagflation but no recession.
Equity Sector Weights
I am maintaining my significant overweight in the Energy sector. However, I am reducing my overweight somewhat in the Materials, Reits, Industrials and Consumer Discretionary sectors. At the same time I am reducing my underweight in Technology, Utilities, Staples, Communications and Healthcare. I am maintaining my overweight in Financials.
Individual Equity Changes
In a blog dated April 19th, I deleted Old Dominion Freight from both portfolios in the Industrials sector.
Industry wide spot freight rates have recently dropped by 20% and this will clearly not be positive for Old Dominion. In the North American trucking industry, I am maintaining exposure to TFII International as it trades at a much lower valuation than Old Dominion and its fundamentals remain sound.
In the technology sector in a blog dated April 12, I deleted Apple from both portfolios. The shares are trading at a much higher valuation than many of its peers and the increase in lockdowns in China will further exacerbate the company’s supply chain issues in that country.
In a blog dated April 14th, I added H& R Reit to both portfolios. This Reit is shifting away from Office and Retail into only Industrial and Residential. The company is already more than halfway there while its valuation is cheaper than many of its peers who are either only Industrial or Residential Reits. In a blog dated April 28, I added European Residential Reit to both portfolios. This Reit provides a dividend yield of 3.35% and offers solid growth in funds from operations. Its properties are mainly in the Netherlands where all cost increases on the properties are borne 100% by the tenants.
In a blog dated April 22, I recommended a switch out of GM into Ford. Ford offers an attractive dividend that is well covered by cash flow, while GM offers no dividend. Prospects for Ford look especially attractive relative to GM with their introduction of the EV engine for their most popular pickup truck.
In my newsletter for May, I have decided to delete Thermo Fisher from the Growth portfolio in the healthcare sector. Historically both Danaher and Thermo have been serial acquirers in the healthcare sector. However new deals seem harder to come by currently. Danaher’s outlook is looking much better than is the case with Thermo Fisher. I am adding both Merck and Humana to the Healthcare sector for both portfolios. Merck is doing much better in the lung cancer front than Bristol Myers and the stock price is starting to reflect this. Humana is one of the largest private health insures in the US. The company offers a dividend yield of 0.71% that is well covered by cash flow. While the yield is low the actual dividend per share is rising nicely. The company has solid projected EPS growth and is trading at a reasonable 17.7 times, much cheaper than UnitedHealth’s 23.21 times.
Lastly in a blog dated May 2nd I added Disney to the Growth portfolio. The shares have fallen sharply over the past year and now trade at a much more attractive valuation than was the case over the last five years.
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