Also available in PDF: McMurtry Investment Report Portfolio – September 2022
Investment Commentary September 2022
US Yield Curve
The 10-2-year US Treasury yield curve remains inverted as of September 1st at a minus 0.25%, but less than last month’s minus 0.41%. Two- year Treasury yields rose by 61 basis points and are now at 3.51% as of September 1st.
US Corporate Debt Spreads
As of August 4, 2022, Baa rated US corporate bond spreads relative to 10-year US Treasuries actually declined by 14 basis points to 2.18%. This does not indicate any immediate panic in the US economy.
Covid – 19 Health Stats
Covid-19 cases in China continue to rise resulting in increased lockdowns of major cities.
Equity Market Valuations
The recent market decline has caused the Forward PE of the S&P 500 to fall back down to 16.7 times compared to 17.4 times last month.
Central Bank Monetary Policy
As clearly highlighted in this month’s newsletter, US Federal Reserve policy remains very hawkish with no end in sight until domestic US inflation falls sharply from current levels.
Asset Mix
Last month the cash weight for both portfolios was 40%, while the equity exposure was 35% for the Income portfolio and 45% for the Growth portfolio.
In a blog dated August 13th, I reduced cash by 5% and increased equities by the same percentage.
However, as I explained in my newsletter, this change in weights was totally a result of US domestic inflation exhibiting clear signs of peaking.
Unfortunately, last week at Jackson Hole, Wyoming, Chairman Powell gave a short speech where he stated emphatically that the Central Bank has no intention of easing off their current interest rate policy until inflation is totally broken down. Based on this presentation, I have decided to go back to my last month’s cash and equity weights, namely 40% cash for both portfolios and 35% and 45% equity for my Income and Growth portfolios respectively.
In this current period of rising interest rates, I continue to recommend a short- term fixed income duration. However, once rates have risen over the next several months to a level that is likely to cause a hard landing, it would be appropriate to increase duration accordingly at that time. Currently I have exposure to both domestic rate- reset preferred shares and floating rate fixed income. Once rates peak, I will be selling both rate -reset preferreds and floating rate bonds as neither will benefit from lower rates.
I am changing my North American benchmark weights to 60% Canada and 40% US, from last month’s 65% Canada and 35% US. The justification for this change is that the Canadian equity market, ex Energy, will not perform as well in a weaker economic environment.
Equity Sector Weights
Based on the weakening economy and corporate profits, I am keeping the underweight for Financials and Consumer Discretionary. I am reducing both the Materials and Industrial sectors from market weight to underweight. I am maintaining my overweight in Healthcare, Energy, Utilities and Consumer Staples. I am keeping my market weight for the Reit sector with the very cheap valuations. I am keeping the underweight for the Growth sectors, namely Technology and Communications as a result of the continuation of higher interest rates. However, I am reducing my underweight somewhat for the Technology sector with valuations becoming more attractive and the fact that Growth stocks tend to do better than cyclical ones in a weakening economy, especially a recession.
Individual Equity Changes
In the Materials sector, I am deleting Equinox Gold from the Growth portfolio. Gold bullion is having difficulty performing in this high interest rate, high US dollar environment. Furthermore, the company is not a mature gold producer at this time and is more susceptible to downside risk being a small cap company. Also, in the Materials sector I am deleting BMO Base Metals ETF, ZMT, from both portfolios. I am trying to be more stock selective by focusing on my preferred list of base metal companies.
In a blog dated August 26th, I added Open Text, the Canadian software company to both portfolios in the Technology sector. The company has a long- term track record of making accretive acquisitions. It recently made a new acquisition, the British software company, Micro Focus, for 5.1 million pounds. The acquisition was made at an attractive price relative to what Open Text is trading for and is expected to materially add to consolidated EBITDA.
Also in the technology sector, I am deleting Paychex from both portfolios. While the company should benefit from rising rates, this will be more than offset from a slowing employment market that the Federal Reserve wants to see from its hawkish monetary policy. I am also deleting Applied Materials from the Growth portfolio in the Technology sector. The US semiconductor industry is expected to experience a major oversupply situation next year and this will not help Applied Materials.
In a blog dated August 18th, I added the US transportation company, J.B. Hunt Transport to both portfolios in the Industrials sector. The company is one of the largest transportation companies in North America and is trading at a reasonable valuation relative to its peers. The company is expected to show strong growth in EBITDA over the next two years.
In a blog dated August 18th, I deleted CP from both portfolios. The stock is trading at a much higher valuation than CNR and there is no assurance that its takeover of Kansas City Southern will be a smooth one.
In a blog dated August 13th, I deleted Parex Resources from both portfolios in the Energy sector. The change in government in Columbia to a left leaning one does not bode well for Parex that operates solely in this country.
In the Financial sector, I am deleting T. Rowe Price from both portfolios. While this is a solid company, it will be hard for this investment manager to generate rising revenues from a portfolio of equities that are falling in price in a weak equity market.
Lastly, in the Communications sector, I am deleting Comcast from both portfolios. An economic slowdown plus much more competition in the streaming area will provide major headwinds for earnings next year.
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