John O'Connell, CFAA Comment -- General Comments From an ExpertA CommentaryN/AJul 13, 2015

Volatile since US midterm elections. US economy still growing, corporate earnings are very solid. 10-year Treasury yields reapproaching and going above 5% has been an issue for stocks.

If you look at the history (going back to 1950) of the 12 months right after midterm elections, you've had 19/19 positive runs for those years. Average return is 15.1%. Next year is the third year of the presidential cycle, and that's the best year for stock markets. Again, back to 1950, the market's been positive every single time with an average return of 20.9%.

He remains pretty constructive.

With the Democrats in Congress, it doesn't mean that AI or the infrastructure buildouts are disappearing. We certainly know that demand isn't disappearing, as the use of tokens is increasing exponentially. 

Separate fundamentals from the fear in the market, and try to take advantage of that.

Room for growth, but also lots of potential speedbumps along the way. He tends not to be in names that are overly focused on that sector.

General uncertainty around the commodity, as there's been for the last 9 months. Not going to see the end anytime soon. Even if we did, we're still in a higher-price era. Lots of damage done to infrastructure in the Gulf, which will take months (if not years) to repair. That puts a premium on oil for many years.

As well, this has shown Iran that it can control global oil prices. Even if peace breaks out, that risk premium will remain. Favourable geography allows them to close the Strait. Every time prices spike, the whole world is on edge. 

The whole region is vulnerable. No one contemplated the type of attacks on facilities, so they weren't built to withstand that. So much of the world's production and reserves are concentrated in that one narrow region, yet many of those countries don't have robust military forces in place to protect themselves.

Iranians have learned what they can do. Now their goal is to push America out of the region. Many places that have been housing US bases have been coming under attack from Iran.

A very smart way to go. You get diversity, and don't have to worry about company-specific risk. 

However, you do have to worry about concentration. A broad analogy is that if you buy the SPY, you think you're getting a broad basket of S&P 500 companies. But all the growth has actually come down to 7 (maybe 10) tech companies.

If you don't spend the time looking under the hood, you don't really know what you're getting.

WCS is the Canadian benchmark, and could be displaced in the future by production from Venezuela. Infrastructure in Venezuela is quite bad, so he's not sure how quickly it can ramp up.

If Canada didn't pursue pipelines to the West Coast, it would really leave the Canadian industry in a very bad spot. That's well understood in both Ottawa and Alberta. So Venezuelan production is a potential threat.

The spread is ridiculously high at this point, but it does highlight how we need to move beyond exporting primarily to the US. All future growth in energy, whether nat gas or oil, is not in America; it's in Asia.

October was an interesting month. Prior to that the market was very narrow, led by large-cap tech stocks.

In October, the S&P 500 (market-cap weighted) was down about 1%. But the equal-weight index was actually up almost 5%. Quite a gap in performance. That tells her that the breadth is broadening, stocks in sectors other than large tech are doing quite well. 

So there was a rotation in the market. Investors didn't necessarily sell the market, they just rotated away from tech and semiconductors toward healthcare and even utilities. Toward things that are more defensive.

That's encouraging. Historically, a bull market is healthier if it's more broad-based.

Exactly. A lot of the industrial names that supply the data centre buildout have pulled back on fears that the buildout will slow, product demand won't be as great, and profits will suffer.

Pullback is healthy, as a lot of those names were trading at very high multiples.

There's a lot of topline growth, but they're not making money right now. They do have cash, and they'll raise more from the IPO.

Very strong last year, decent performers this year. Higher rates bring concerns about the housing market. Reserve provisioning for loan losses has likely peaked, so reserves may be released.

If you think Canadian economy will improve in 2027 under all the nation-building initiatives, along with trade flows, then the banks will benefit. That said, yields are lower. RY and TD are now below 3%, which is a reflection of how well share prices have done. Dividends are still being increased at a moderate pace.

For clients who need $$ and whose weighting has gone above target, she's been using the banks as a source of funds. Otherwise, still holding for the long term. Don't chase to add new money at these levels, wait for a pullback.

The Canadian budget will run hefty deficits for the next few years: a deficit in line with 2-3% growth in the economy is not something that would significantly to the debt over time. The problem happens when deficits far exceed potential economic growth. That was a factor in the last government for sure. Things are a little better. For instance, oil prices were higher so oil royalties were a lot stronger in last year's budget. Not sure if this will be repeated. When times are good, governments should reduce, not add to the debt load. The bond market: with recent highs, yield were around 5.70-5.75%, which makes it pretty compelling as risk-free money over 30 years. There are challenges to valuations like Apple's which should be lower, so this makes government bonds become attractive. U.S. company earnings are still good. Forward estimates continue to inch up.

The big banks make up 24.33% of the TSX; metals and mining 17%, oil/gas 14.5%, software 7.14%, insurance 7%. The budget offers slightly more headwinds than benefits, such as more competition for the banks, but more of the beneficiaries will be in the private sector, not public. Metals: this sector will grow, but mining is cyclical. Also, critical minerals mining is very small in Canada. So supporting this sector doesn't benefit the TSX much overall. Energy boils down to commodity prices, so the budget can't control that. The outlook for oil/gas is negative. It doesn't matter if we build more pipelines, though getting oil and gas to foreign markets will increase Canadian market share. Overall, the best play is the utilities sector and he recommends the XUT ETF.

The company is about to go public.

We have this AI selloff. It's not that people have stopped believing in it, but they're questioning the economics of the buildout. Will the returns justify the investment? A technological revolution doesn't necessarily guarantee a profitable investment. In the era of railroad-building, many went bankrupt and a lot of people lost money. AI could follow the same pattern.

You want to look for the businesses that are going to capture the resulting productivity gains. Businesses that have moats, durability, and can exploit AI to their productivity advantage. It may not be those who are producing the intelligence. Healthcare is a space that's ripe for disruption from AI.

Focus on diversification. Manage the inflation and growth risks in your portfolio. Make sure you have the risk right during all this market chaos. If your portfolio was uncomfortable during recent weeks, use any year-end rally to get your risk balance on par with your risk objectives.