Paul Harris, CFAA Comment -- General Comments From an ExpertA CommentaryCOMMENTJun 26, 2020

The middle of October is usually a pretty dark period for equity investors. Midterm elections, an Alberta election, a Toronto election. And then all these gate points that have missed -- CPI yesterday was worse than expected, PPI today worse than expected, US retail sales not so good without gasoline.

Investors are, rightly, reassessing risk. Whenever you have bond yields move the way they have in such a short period of time, people take a great deal of notice. How will that impact business decisions?

Essentially, the bond market has done the work for the Fed and the BOC on rate hikes. The thing that investors have to analyze is whether, in that higher interest rate world, they're still comfortable with their equity exposure? From tech baskets to neoclouds. That's the angst we've had for the last 6 weeks.

Easy to point it out, but the bigger question is how does it resolve itself? Where do we go from here?

Doesn't think so. Normal and very healthy for investors to have this gut check. We're still climbing that wall of worry, and people are still sober. People aren't seeing the once-in-a-generation opportunity that is before us.

This is a 4-year bull market, and it's been pretty generous. But it can be way, way more generous -- as long as we don't have exogenous shocks or really big policy mistakes by the Federal Reserve. If we can contain inflation, and if yields are where they are for the right reasons, that is growth. And there are great places to be.

However crowded the tech stocks are (and the whole world's looking at them), they're still not expensive. Many are trading at a multiple relative to the S&P. S&P's trading at 19x PE for 2027, and that's its 10-year average.

Shows the imperative of owning a diversified portfolio. No matter how high-quality a name is, we all know the lessons of GE 20 years ago. Or Bombardier 30 years ago. Really good stocks can disappoint you at times.

No one silver bullet. So many ways to build wealth in the stock market it's staggering. If you buy the right stocks, and you have the right time perspective, you can do well. Look at SHOP, or even the banks.

Can you do as well with ETFs? Probably not quite as well as being a good stock-picker. But you can still do really, really well. Depends how conservative you are, and what you want to achieve.

The key for him is to have a diversified portfolio, and use ETFs where you don't have an edge. If he's looking at Japan, and he really doesn't have an edge, he's going to buy the ETF. Or if he needs currency hedging.

It doesn't change his expectations for a second rate hike there. There are a number of things contributing to it. Defence spending is quite high, as is AI infrastructure spending. Plus the dislocation in energy markets. It's been hard to get inflation under control.  

The problem the Fed's facing right now is that inflation's been above their core target for more than 5 years. So the new Fed chairman is taking a harder line.

If you look at the futures curves, it looks as though we could have a second rate hike later this year. But it's a dynamic environment, and things can change quickly.

Yes. Fear seems to keep growing daily because of uncertainty. For example, how will the midterm elections play out? 

One thing that gets glossed over is the fixed income market in the US. Foreign countries own US treasuries. If US trade with those countries goes down, their ability to hold those securities goes down as well. Japan's bond market is internally sourced, while the US has a bigger reliance on foreign investors. 

The uncertainty negatively impacts the rate outlook.

What you're looking for on valuation doesn't change. But your return expectations do. In Canada and the US you get very concentrated markets, and with those come pockets of overvaluation.

Important to have a disciplined process and rebalance. In Canada, the only things flying high right now are financials and energy. In the US, it's the tech names. A lot of sectors are still really down on their luck, and you can find some good opportunities.

He finds this sector puzzling right now. (He started his career as a bank analyst, and has been around them his whole career.) The valuations today are not seen very often; about 20-30% above 5-year averages. EPS growth in same range. Not sure if it's because money has flowed out of the US and into Canada? Pretty sure it doesn't have to do solely with growth outlook for the banks.

Very shareholder-friendly. Great dividends (though yields have come down as valuations have gone up). Buying back lots of shares. Rising rates pose a challenge, making the valuation of Canadian banks a bit vulnerable.

If you own, consider rebalancing a little bit to free up some capital. Don't exit entirely. To allocate new capital, just wait.

Tough to know, and tough to time it. He finds it easier to recognize value and be patient enough to wait. With fund flows so fast these days, things can rerate in just one quarter. If you wait too long, you can miss your opportunity. So he tends to get in once he sees the value.

The price you pay dictates your return. If you get in at a good price, you can get earnings growth and multiple expansion for a great total return.

The deal between the US and Russia for diesel is a drop in the bucket and will have little impact. What's interesting is the US seems to have relaxed the sanctions against Russia, but now faces US bi-partisan pushback. He'd be surprised if this deal goes through, considering many Republicans oppose it. He doesn't see an end to to the US-Iran war. Iran has leverage and will string out this war for as long as they can to gain even more leverage. He's amazed that some believe that oil prices will fall after the U.S. midterm elections. In Canada, Alberta's premier first proposed the TransMountain extension a year ago, but nothing has been done so far. Carney isn't moving at breathtaking speed, as promised.

It's been underway since late August, but more evident in the TSX than in the S&P 500 (which is being narrowly held up by a narrow group of names).

The TSX is actually down roughly 5% off its late-August peak. Difficult to pinpoint any one reason. It's a broad-based selloff, a stealthy bear market.

Number one would be high oil prices, more problematic in the US than in Canada (given our heavier weighting in energy names). Inflation. Interest rates. Bond yields at 20-year highs.

Another shoe dropped this morning with the Canadian jobs report, massive job losses in September.

We're seeing anxiety around tech, and we're certainly not in the early innings of the AI story. Seeing more and more concerns about AI. 

Will the colossal spending generate returns commensurate with their cost? The other things people are getting increasingly anxious about are guardrails, governance, and potential regulation around AI. It cries out for a globally coordinated approach. With globalization fracturing by the day, that's not happening.

All that angst is hitting the market.

As for earnings, tech earnings are going like gangbusters in the States. Yet there are jitters. Yesterday saw an erroneous news release about OpenAI's revenue being overestimated, and then retracted. That caused a big selloff in the tech complex yesterday.

A good way to summarize it is that there are a lot of "nervous hands" on these tech stocks.