Opinions
Larry Berman CFA, CMT, CTA A Comment -- General Comments From an Expert A Commentary N/A Feb 12, 2018
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Correct, as we've seen such an extended rally. Valuations are very high, especially in US stocks. People seem to be ignoring potential risks such as tariffs, and rhetoric has accelerated in the last week or so. If you look from January 1 to today, you have more geopolitical risk, earnings estimates coming down, US market continuing to rally. He's a little more positive on Canada.
Investors are being complacent right now, and it's time to be a little bit cautious.
The bond market's really telling us it's concerned about inflation, the US deficit, and tariffs potentially being inflationary. With today's additional tariff rhetoric we've seen bond yields moving up. That's a clear sign that the bond market has one view, and people often find that the bond market is a better gauge than the equity market of what's going on from a macro standpoint.
Equity market's being driven by momentum, retail investors, a lot of hype around AI. AI will definitely be important, but we don't know how profitable companies are going to be from this massive capex investment. A lot of positive news is already built in, and the market's focusing on that and pushing all the negatives aside.
He doesn't typically tend to have a ton of commodities exposure. He owns a bit of gold and a bit of energy, but overall his firm is not a heavy commodity investor. It is the time for defensive businesses with good cashflow generation, and value investing should have a bit of a comeback. He favours Canada over the US right now for equities.
It's always about what the market is going to deliver relative to expectations. The bar isn't particularly high this quarter. We normally get about 70% of stocks beating earnings.
The story is going to be what they say about tariffs and margin compression. Not sure enough companies know yet what that's going to look like. If you look at the 6.5% earnings growth estimated over the next year, it doesn't seem a stretch at this point. If we get nominal GDP growth of 5-5.5%, those numbers are achievable. But that nominal GDP growth number assumes no margin pressure from tariffs and a pretty decent economic outcome.
In the "big, beautiful bill" we get some current stimulus and tailwinds over the next year, they're not what we saw in terms of tax cuts in the TCJA passed during the first Trump administration. But there's also massive bond supply being a headwind to future growth.
It's not going away anytime soon. If the tax revenues through tariffs are elevated enough to mitigate some of the need for bonds, that would be a good story from a debt finance perspective but a bad story related to margins. Either we're going to get inflation, or margin pressures, or bond yields are going to have to back up a little bit more. It's one one of those three things or some combination of all of them. To him, the market is priced for a more Goldilocks-type of outcome.
We've been in a situation like this before, where equity markets surprise to the upside. So we can't be too confused by that. See today's Educational Segment for some ideas to deal with that uncertainty and where to put your money if you're worried about growth.
There is. Speaks to the whole universe of Canadian Depositary Receipts that have come up. You can buy fractional shares with an embedded currency hedge in a lot of the big names in the US. If you feel the CAD is very low here, and you want that US exposure, you're probably better off buying it with a CDR that has currency hedge embedded in that exposure as opposed to buying the stock on the US exchange.
If you like the stock and think the CAD is expensive and likely to get cheaper, then you want to own the US dollar version of that and keep your exposure to the USD.
Larry thinks the CAD is somewhat undervalued right now in the context of the next 5 years. Fair value for the CAD is probably somewhere between 75 and 80 cents. When it's below 75 or 70, you want something that's hedged. When it's above 80-85, you want the US dollar exposure. If it's somewhere in the middle, you're a bit indifferent to the currency risk.
You can buy an ETF that's listed in Toronto that has the euro exposure. For example, ZWP gives you exposure to the euro via a Canadian holding.
This question is probably prompted by the whole narrative around a weaker US dollar and the euro getting stronger. That's very much a USD-Euro story, than a CAD-Euro story. So you might need to look more for a US holding than something in Canada.
FLUR gives you international exposure. XEU gives you broad exposure to MSCI Europe.
Are you getting compensated enough by that additional yield for a shorter-term bond to take that interest rate risk? Right now, he prefers the US to Canada. Canadian long-bond yields are about 125 bps below those of the US. So he's not wild about them.
Much prefers the long end of the US curve where the yield is north of 5% at this point. But the challenge is the currency exposure. It speaks to being a sophisticated investor in terms of bond exposure. If you think a hard landing's coming, they'd absolutely be good for a trade. Institutional investors can do these kinds of trades all day, much more difficult for individual retail investors.
Tweaking Investment Exposure
He often gets questions whether it's a good time to invest now, and it's usually new money coming off the sidelines. Right now, the US equity market's at all-time highs. One of the ways you can be a bit more conservative at times, or aggressive at times, is by looking at different ways to get exposure to the US large-cap area. And you can do that by using factors.
He brought along a chart of 5 different ETFs as ways to play: SPHB, SPLV, SPHQ, SDY, and SPY.
SPY -- low-cost MER, broad S&P 500 exposure.
SPHB -- S&P, high beta. Rebalanced a couple of times a year into the higher-volatility names. Typically exposed to ~20% of the index.
SPLV -- S&P, low volatility. About 20% of the index, typically higher yield. In the long run, similar returns to the broader market.
SPHQ -- his favourite factor. High quality. In the long run, uses filters to give you 20 names of the highest-quality companies in the S&P. Good balance sheets, less sensitive to the economic cycle. Some dividends, some growth. High-performing names. If you can handle the ride, this is the one to buy and hold.
SDY -- a way to play the S&P with a dividend basket.
Reality is that depending on what kind of investor you are, there's a different solution for everyone. Right now, with markets at all-time highs, he's not comfortable telling people to take $$ out of the bank and put it in the market. If you did right now, he'd say to go low volatility or high dividends. Because...look at his next chart.
The next chart shows that, during volatile periods over the years, when it's bad (as it was during Covid or 2015-2016) the low volatility and higher dividend options give you a better experience. They keep you invested, with more yield and less downside. But after a correction (typically about 13%), you want to pivot and shift into high-beta names for more growth, the broad S&P, or high-quality names. But do this when markets are cheap, not when they're expensive.
Learn which tools work in which environment, but there's an ETF for just about every person out there. Always stay fully invested for the long run, as it's really the best thing people can do. But tweak your exposure, so if we go through an adverse period, it's a little bit less bad. We can't time markets perfectly.
Balance. Bonds and stocks have sold off at the same time recently. Equities have much more volatility than bonds so you need both to reduce overall risk. How much of each depends on your needs and your tolerance of risks. Equities may continue to be soft while bonds may rally.