Frank Mersch A Comment -- General Comments From an Expert A Commentary N/A Jun 15, 2018

You have to think about what consumer prices are going to look like and how consumers may have to cut back. 2/3 of all economic growth comes from the consumer. If they have to cut back on spending, then changes are that profitability may be weaker in the coming quarters.

His team sets a plan and sticks to it. In a 30-stock portfolio, he'd have about 4 Canadian, 13 US, and 13 international. It's not where the companies are domiciled, it's about where the revenue streams are coming from. 

He's gotten emails over the past weeks about the CAD vs. USD. Important to understand that currency risk becomes benign over a 10 to 20-year time horizon. If you think about the USD vs. CAD, the annual change over 25 years has been 0.2%. With Europe, it's been 0.6%. So don't fret.

His approach is to have a list of stocks, and each client's portfolio is customized with 30 names. They look at the percent weightings in the portfolio. When it comes time to do some buying, they look at the ones with the lightest weight because those are the ones that are down the most. The expectation is that, at some point in time, profits will return and stock prices will turn around and start to go up again.

Stay in the game. Protecting your losses is much more important than how much you make.

The way they manage risk is to not only keep the percent weightings in line, but also to keep 50% in the 4 inelastic industries:  consumer, healthcare, financials, and utilities. The other 50% can go in the more volatile technology or industrial sectors. By country, again, he keeps that 20/40/40 mix among Canada, US, and international. 

He wants to have 50% in large caps, where most of the profits are being used to pay out dividends, and that's the income side of the portfolio. Still wants to have another 40-50% in small-mid caps; that's because more of the profits are going back into the business for capital appreciation over time. This way, you get that nice blend of income and growth. Dividend growth offsets inflation.

He doesn't have to chase sectors or areas because they're already global managers. So when EMs and Europe took off, they were already there and benefited from it.

He favours insurance companies over banks right now. What's going to happen when all those people who bought houses in 2020 with 20% down, with 5-year fixed mortgages at 1.5%? The value of their home has dropped 20%, now they have no equity in their house, and they suddenly become high risk. 

Canadian banks haven't yet had to face this problem. If payments double or triple, and more income has to be allocated to debt repayment, that will impact loan loss provisions and profitability. Most banks raised provisions, but not enough. BOC may have to lower rates to keep the economy going, and that's not good for banks either.

Markets are becoming somewhat desensitized to the rapidly changing tariff outlook. President TACO spoke out on Friday, so markets didn't have a real chance to respond. So last night, as futures opened, they were softening. But this morning, we're right back to an upswell on the day for the US market.

On today's Educational Segment, he'll talk about where he thinks the focus will go and, ultimately, hard economic data and how the economy will play out in the back half of the year with all these things factored in.

President Trump knows that low oil prices are needed to contain inflation. We're in a regime where between now and the midterm elections, from a US perspective, low oil prices are a good thing because that will help the average family.

Oil prices have come down. Over the last 3-4 years, it was thought that under $70 the US would be buying back for the strategic petroleum reserve. Now he thinks they will, but it will be below $50 at some point. That support for the market's been deferred. As long as supply exceeds demand, prices will remain well contained, notwithstanding the little bump we got today.

We're going to be in a heightened period of uncertainty, and tariffs are part of that. Increasingly, we're starting to see some economic data that's starting to soften. To him, the recent pre-April highs are good highs; we're not going to go through them. Unless, that is, we see a significant uptick in economic outlook. And he just can't see that with all the uncertainties in front of us yet to be resolved.

That said, the extreme low from April is probably a good low until we see a really hard economic landing where we're talking about massive layoffs and recession. That doesn't appear to be on the agenda for this calendar year. Something to worry about down the road.

Right now, there's a 20% chance it cuts rates. None of the big 6 banks are expecting a rate cut. So he doesn't think we'll see one, though GS is expecting one. BOC is pre-emptively way ahead of the US market in terms of cutting. Still, we get employment numbers this Friday and we're likely to see a loss of jobs in Canada.

Canadian economy is structurally weaker than the US right now. BOC will be biased toward cutting further as we progress.

There are ways to buy a US security that give you exposure to other parts of the world. US money market or HISA would get you a 4.5% yield. There are USD instruments that trade in Canada.

He'd ask how fundamentally opposed are you to getting a better return on your money in light of anti-US sentiment based on politics?

US economy.

As we get desensitized from tariffs, though those are still real and still matter, we're starting to see decay in the US labour situation developing over recent months.

He's brought in a graph of the JOLTS survey on job openings / losses / turnover going back a couple of years. Number of job openings is continuing to fall. The need for workers is falling. 

Last week saw another uptick in initial jobless claims data. It's very cyclical. Generally speaking, in the post-Covid normalization we've hovered in a range. We're now back up to the top end of the range, and we're worried it will break to the upside. We just heard that DIS is laying off people. That's a big part of what the market's going to start to care about, as it means the Fed will be off the sidelines and maybe start to cut rates.

That's initial claims. What worries him a bit more are the continuing claims. The graph is at a multi-year high for those numbers. Since Covid, it's taking people who have lost their job, longer and longer to find a new job.

So you have less demand for labour from business (fewer job openings). You have an uptick (though modest) in initial jobless claims. And then you have the extended continuing claims. Those things are combining, and this Friday we get non-farm payrolls. There's some expectation that we get job growth, not negative, but less than 100k. If we start to see the US labour market weakening, it's going to matter a lot because the market (at 22x forward PE) is priced for 8% earnings growth this year.

If we start to lost jobs, and recession risk becomes real, then equity markets are not priced for that risk.

Finally, we have the big beautiful bill. A gentleman on social media at Piper Sandler took all the components of the bill, and calculated that we'd get an economic bump into 2026. But the growth rate for GDP following that is going to decline. It won't be the economic boost they hope. Larry's not sure the markets are correctly priced for what's coming.

Bottom line:  if you want to participate in the US market, use buffer ETFs. ZJAN is his recommendation. Gives you about 10% upside, and about 15% a year downside protection. Keeps you invested, in case he's wrong and the market goes higher.