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Investment Commentary November 2022

US Yield Curve

The 10-2-year US Treasury yield curve remains inverted as of November 2^nd with an increase in its inversion from minus 39 basis points in September to the current level of minus 51 basis points.

US Corporate Debt Spreads

As of November 2, 2022, Baa rated US corporate bond spreads relative to 10-year US Treasury yields actually declined by 28 basis points to 1.99%.

Covid – 19 Health Stats

Although Covid lockdowns in China continue, these will gradually ease off in 2023.

Equity Market Valuations

The forward PE of the S& P 500 is currently at just over 16 times as of November 2^nd.

Central Bank Monetary Policy

US Federal Reserve policy remains very hawkish with no end in sight until domestic US inflation falls sharply from current levels. However, there have been a lot of rumours about a Fed pivot. This week the Fed Funds rate rose again by 75 basis points with an additional 50 expected in December. Wages and rents remain the sticking factors in the inflationary outlook. As I have mentioned several times in the past, these factors are not leading indicators like money supply growth is. US money supply aggregates continue to collapse and this is resulting in a very sharp decline in overall mortgage demand. House prices are falling as well as most commodities except crude oil. Most leading indicators point to an upcoming economic slowdown that will result in US domestic inflation easing off. It is just a matter of time before it does. This week the monthly employment data showed a stronger increase in employment than anticipated. Average hourly earnings in the US rose 0.4% in October and 4.7% on a year-over-year basis. Although employment rose more than expected, a rise in the unemployment rate to 3.7% indicated some relief in the employment demand/supply conditions. Nonfarm employment has gone down from October 2021’s level of 677,000 to the October 2022 level of 261,000. The number was 315,000 in September.

Asset Mix

In a blog dated October 25^th, I increased equity exposure by 10% to 35% and 45% for the Income and Growth portfolios respectively. Cash has now gone down by the same amount to 40% for both portfolios. Even though the probability of a recession next year has sharply increased, timing the market’s ultimate bottom will be impossible to predict accurately. Consequently, I have chosen equity exposure at the low end of an acceptable range for each portfolio. It is still possible that we may end up testing the recent lows, but I do not think so. Equity markets normally start going up six months before the middle to end of a recession. Equity market breadth continues improving with the percentage of stocks above their 200 -day moving average climbing back sharply from recent lows. The same trend is evident for both the S&P 500 and 100 Indices.

As a result of a total lack of flexibility for their clients. I have removed Alterna Bank High Interest Savings accounts for both portfolios. I would replace it with a combo of your discount brokerage’s high-interest savings accounts or ETF’s and EQ Bank which offers both savings and GIC’s for both registered and non-registered accounts. Please keep in mind that your discount brokerage high-interest savings accounts are probably not covered by CDIC insurance, while EQ Bank savings accounts and GIC’s are totally insured up to the maximum ceilings of $100,000 per financial institution.

 

Equity Sector Weights

I remain overweight my North American benchmark Energy, Healthcare, Consumer Staples, and Utilities.

I remain underweight Technology, Financials, Materials, Industrials, and Consumer Discretionary.

I remain market weight Reits.

The only major change I am making this month is to increase the Communications weight from underweight last month to market weight this month. While this sector is getting hurt similar to the Technology sector, there are companies I particularly like at this time. The Canadian telcos – Telus and Quebecor offer solid dividends and some growth in this current period of economic weakness. I also like Disney for its unique growth opportunities. Alphabet also offers solid long-term prospects despite its current short-term issues. Lastly, Electronic Arts continues to trade at a low valuation on an Enterprise Vale to Forward EBITDA basis.

 

Individual Equity Changes 

In the financial services sector, I added PayPal to the Growth portfolio in a blog dated October 27^th.

The share price has been unfairly punished with its share price off over 67% from its 52 -week high. While there is more competition in the payment field, both Visa and Mastercard have not indicated any interest in competing for small online merchants which are PayPal’s bread and butter. Revenues, EBITDA, and EPS are expected to rise nicely in 2023 even in the midst of this difficult economic period. The shares trade at a forward PE of 18.39 times, at the low end of its five-year range.

In a blog dated October 24^th, I added Lululemon to the Growth portfolio in the Consumer Discretionary sector. The company has solid growth prospects, yet its share price has fallen almost 32% from its 52 -week high. The company has no long-term debt and does not own any manufacturing facilities. Differing from its competitors, the company has maintained stable operating margins in this period of high inflation. The stock’s forward PE is trading at almost 33 times which is at the low end of its 5 -year range. EPS and Revenues are expected to continue to grow strongly next year.

Also in the Consumer Discretionary sector, I am deleting Gentex from both portfolios. The shares are trading at a much higher valuation than either Ford, GM or the auto parts companies. While both EPS and EBITDA are expected to rebound next year, EPS revisions continue to decline into 2023. This is not a good sign and indicates to me that the bottom-up analysts are too optimistic and only beginning to adjust their projections down in this period of weak economic growth.

Also in the Consumer Discretionary sector, I am removing Home Depot from both portfolios. The shares continue to trade at a much higher valuation than Lowes, yet its dividend payout is much higher as well.

Lastly in the Consumers Discretionary sector, I am deleting Sleep Country from both portfolios, While the stock’s valuation has remained much lower than its peers, the bottom-up analysts covering the stock appear to be slow on the mark lowering consensus EPS estimates. The most recent quarter saw revenues and EBITDA fall year over year by 8.3% and 10.9% respectively. Same-store sales went down by 11.1%.

In the Industrial sector, I am deleting TFII from both portfolios. The company is just starting to experience weakening fundamentals and these are expected to continue throughout 2023. EPS revisions are falling sharply for both the current upcoming quarter and into the following year.

In the Utilities sector, I am adding both Boralex and Brookfield Infrastructure to both portfolios. In a portfolio blog dated October 18^th I added Boralex, a Canadian company with its entire focus on renewable energy in the forms of wind, solar, hydro, and thermal. Currently, the company is the largest independent producer of onshore wind power in France. The company offers solid growth prospects in wind. solar and storage projects. Also in this same sector, I added Brookfield Infrastructure to both portfolios. The company offers exposure to global long life infrastructure projects with stable cash flows. Approximately 85% of its current business benefits from rising inflation.

In the Reit sector, I am making several changes to the current list of holdings. In a blog dated October 19^th, I added the US logistics Reit, Prologis, to both portfolios. The company is a global leader in industrial warehouse rentals and has recently just completed a major acquisition of Duke Realty. This acquisition will provide Prologis with additional growth prospects. Prologis has a strong balance sheet with its average interest rate on its debt at 1.9%.

In regards to Canadian Reits, I am deleting Canadian Apartment Reit, European Residential, and lastly CT Reit from both portfolios. European Residential is unfortunately having to operate in the current very challenging European market. Canadian Apartment Reit is currently trading at a much higher valuation than InterRent, yet its growth rate is comparable. Lastly, CT Reit has outperformed other Canadian Reits over the last year. However, its projected growth rate is lower than the others and yet its valuation is considerably higher with the exception of Canadian Apartment Reit.

In the Technology sector, I added Adobe to the Growth portfolio in a portfolio blog dated October 17^th. Adobe’s recent acquisition of Figma was not received well by the market. The acquisition is expected to be dilutive to EPS in 2023 and only start to be accretive by 2025. However, the purchase of Figma is considered very strategic as the company is much more flexible and adaptable to its clients than Adobe is. Adobe is currently trading at just under 21 times forward EPS, at the lower end of its 5- year range. This is an opportunity to acquire a high-quality tech company at a very reasonable valuation given its long-term projected growth rate.

I am deleting Qualcomm from both portfolios in the Technology sector. The company’s third quarter was very disappointing indicating a complete collapse in the outlook for smartphone chips as a result of the continuing oversupply.

In the Healthcare sector, I am deleting Medtronic from both portfolios. Despite the economy opening up after all the Covid lockdowns, medical procedures to install devices have remained relatively weak for the industry as a whole. The same trend is evident with Stryker. EPS revisions for next year continue declining for Medtronic.

I am also deleting Danaher from the Growth portfolio in the Healthcare sector. The company is experiencing poor EPS visibility with not a lot of mergers and acquisitions happening in the healthcare field.

 

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