A Comment -- General Comments From an Expert (A Commentary)

What is Direct Indexing?

With news of numerous brokerages going to $0 trading commissions, the trend toward direct indexing just got a lot more compelling for investors. Direct indexing essentially lets an investor buy the underlying securities within an index (say the TSX 60 or the S&P 500) automatically at their broker without owning them through some sort of fund or ETF. When you had to pay $5 to $20 per trade, this was not a particularly feasible approach. But now, with free trading commissions in the US, this strategy just got a lot more interesting and could actually give ETFs a run for their money. 

Likes Canadian banks as a group, well capitalized. Likes them better than Canadian lifecos, so she'd stay with the banks. Banks give attractive yields, and she doesn't think we're going into a deep recession in Canada or the US.

The last few days, we've had encouraging data on the inflation front in the US. CPI came in at 3%. Core was still pretty high at 4.8%, but there's a rent component (about 1/3 of the calculation) in there that's keeping the rate up. That number should start to moderate with new supply coming onstream.

This morning, we got the PPI number of 0.1% YOY and core up 2.4%, which came in weaker than expected. This is good news on the inflation front. Somewhat of a leading indicator, as it's a measure at the producer level. Whereas CPI is at the end-consumer level. Those two numbers give a positive tone to the US market in general on inflation. If producers aren't facing higher prices, then they're less likely to increase prices for the consumer.

Right now, consensus is that the Fed will continue to raise by another 25 bps at the end of July. We'll see if that actually happens. 

It's going to be very important to hear what the companies are saying in terms of cost and materials pressure. Is labour inflation starting to moderate? What are they seeing in the economy? What are their capital expenditure plans? What they spend is another company's revenue.

Q2 earnings are forecast to be down by 0.5% YOY. This would be the third quarter where earnings are down, and this one would be the worst. Earnings for Q3 and Q4 are supposed to be turning positive. For the year as a whole, earnings for the S&P 500 companies are seen to be slightly up, and up the following year.

So right now, the market is baking in a soft landing. Typically when there's a recession, corporate profits will turn negative for the year.

Today's topic of the day can quickly displace previous topics that we thought would last for a while. Regional banking issue in the US was a watershed moment because the Fed took its foot off the accelerator of tightening. 

He looked at the moment in time when the big technology stocks took off and left the rest of the market behind, which was early March, and it was almost to the day that SVB went under. It signalled that AI was rearing its head, but that the Fed would become more accommodative because of the problems created by an accelerated move higher in interest rates.

See his article at goodreid.com, under Insights, "US Market Bifurcation: A Story of Two Markets". The story is about those very few (6 or 8) companies that are responsible for the vast majority of the gain in the US equity performance in 2023. The good news is that whenever this has happened in the past, the leaders haven't fallen back to the pack but, rather, the others have caught up. 

To investors, you want to understand what sectors haven't performed well. Healthcare and energy. They've trailed, multiples are at historic lows, strong fundamentals, very good opportunity there.

He doesn't see a prolonged downturn. If you look at sentiment indicators and the AAII numbers, bullish sentiment is at the highest it's been since early 2022. Might indicate the markets are a bit ahead of themselves, which is not unusual. 

At some point, we'll have a normal bull market correction. That's healthy for the market, and it's a good opportunity for those who've been hesitant to enter the market.

You have to be very careful of buying into a company that has a sparkling dividend yield. It has to be supported. If it's not supported, then pass.

What is Cash Flow Yield?

In order to temper inflationary pressure, the Bank of Canada has raised interest rates significantly in the last two years. The most recent one was an increase of 25 basis points to 4.75% in June 2023. As a result, fixed-income assets like bonds become an attractive asset class once again after being ignored by investors for many years due to their low yield.

As investors, we constantly compare available investment alternatives to get the best returns with the lowest risk out of every dollar invested. With interest rates at approximately 5%, conservative investors might only find equity investments attractive if they can get at least a 5% free cash flow yield with a high degree of confidence, in addition to some potential for added returns through organic growth (price increases and volume gains without significant capital investments) and business improvement.

The equivalent yield that a business offers is often referred to as free cash flow yield. Free cash flow yield is basically the net cash that could be taken out of a business each year after taking into account all expenses and capital expenditures to maintain the business without affecting its underlying fundamentals. This free cash flow could be allocated by managers in the best interest of shareholders either to pursue growth through capital investments, acquisitions, or being paid out to shareholders through dividends or share repurchases. 

Consumer inflation came in much lower today, but we're not out of the woods. Key inflation indicator, home prices, are surging (the American dream is nearly impossible for many and that's unacceptable). Also, businesses are still expanding and there remain too many jobs chasing too few workers. The Fed has no choice but to keep raising rates.

Inflation in the first half of 2022 was elevated, up to 1.2% one month, but has since fallen to 0.2-0.3% monthly. So, the US Fed will raise rates once or twice to meet their goal of 2% inflation. It's unlikely inflation will spike. Megatech stocks should do okay in earnings season; they're cash machines. Tech stocks are going to moon: inflation is lowering, the AI craze is on.

Expecting Bank of Canada to raise interest rates this week.
Canadian & US employment numbers stronger than expected.
Inflation sticky, remains a problem for Central banks.
Cost of money (interest rates) major factor in corporate decisions.
A.I. euphoria will remain, as we are early in cycle for this new technology.
Question is how to much to pay (P/E ratios etc.) for certain A.I. stocks.
Very excited about long runway of A.I. technology - believes is early days for potential.

Thinks US Fed should keep raising interest rates, and sell publicly owned debt.
US Fed has expressed goal for quantitative tightening the next 5 - 10 years.
$10 trillion needs to come off US Fed balance sheet in order to stabilize. 
Higher interest rates is going to make US Federal debt very expensive.
Inflation will not allow US Fed to stimulate economy. 

The Power of Consumption Deferral and Early Investing for Retirement Savings.

A reminder to those that are still in the early years of accumulation that time is on their side. Even though the leverage in the later years is much lower than those at the age of 20, at the age of 55, $1 invested growing at 7% per year still represents a 2X return on that investment, certainly nothing to scoff at. Understanding the power of consumption deferral and early investing is crucial for building a successful retirement plan. By capitalizing on the advantages of time and compounding, individuals can maximize their wealth and ensure a secure financial future. Start early, harness the power of compounding, and set the stage for a prosperous retirement.
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There are many more job openings than long term unemployment so it's hard to have a recession when everyone's working. Basically if there is more unemployment then there would be a reduction in wage pressure and consumer spending. There have been wage increases for the lowest 20% of income earners which is a good thing for the economy. There is a report that over half of Canadians are $200 away from not being able to pay their bills. Many Canadians are living paycheck to paycheck but this was the same situation 3 to 5 years ago. Financial stocks are unlikely to be in trouble because we are not expecting a wholesale default on mortgages in Canada. Also a large proportion of Canadians don't own their own homes. There has been a modest increase in defaults on credit card debt and auto loans.