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

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.
Unlock Premium - Try 5i Free

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.

It amazes him Wall Street's undying faith in the Chinese economy, of it being the best market in the world. And yet this is a country with 21% youth unemployment and this is a growth economy? China needs a better relationship with the U.S. 

US jobs report slightly below expectations - but still at a healthy number - which indicates strong economy.
Economy has continued to grow with strength across the board.
Expecting inflation to trend down.
Believes stock market will go higher in the second half of the year.
Corporate earnings less important than forward looking guidance. 
Believes A.I. will continue to be front-and-center within tech sector.

Maximizing Wealth For Retirement.

Starting to save early, even with smaller amounts, allows for a longer investment horizon. This extended time frame creates an opportunity to weather market fluctuations, benefit from long-term growth trends, and take advantage of the compounding effect. The growth of wealth over several decades can result in a substantial nest egg for retirement. Moreover, the power of consumption deferral comes into play. By resisting the urge to spend excessively and instead saving and investing a portion of income, individuals can defer immediate consumption in favor of long-term financial security. This practice, combined with early investing, sets the stage for a robust retirement portfolio that can provide a comfortable lifestyle in later years.

Framed another way, we have taken the average present-day value of a $1 invested at each five-year age bracket with a 7% annual return. For example, between the ages of 20-25, $1 invested until the age of 65 represents a roughly 18 times return on investment. Here we can really visualize the importance of building a retirement savings plan in those years between the ages of 20 to 35.
Unlock Premium - Try 5i Free

Expects more volatility. We're jumping from data point to data point. Every time something's announced, the markets take that as an indicator of what's next to come. This morning we got ADP numbers from the US at 497K, with the estimate being 225K, wildly higher. This number measures the private sector estimate of job growth in the US.

These things create volatility, and that's what we're seeing in markets. The broad market TSX index is up 3-5% YTD, and the S&P's up 15%. These numbers don't really tell the whole story, as we have some really high flyers in both the TSX and the S&P. SHOP is up around 78% YTD, CSU is up in the 40% range. Then you have NVDA and TSLA in the US that are really driving a big part of those returns. Underneath that, you have a broad market that's really quite volatile.

We'll continue to see volatility until we get some clarity from the Fed and other central banks on interest rates. 

He ratcheted up his fixed income, and is staying short duration, but hasn't moved a lot in there. If the inflation numbers start to trend down below 3%, the Fed will be reasonably satisfied with that. This is going to take time to churn through. We just have to wait and see how the economy reacts to 5.5% overnight lending rates. 

Consumers seem to be very resilient on spending, but that's going to wear thin in time. That's when we're going to feel more comfortable, when the Fed and other central banks see an end to the hiking cycle.

He got it a bit wrong too. He anticipated China to come back much earlier, and clearly that hasn't happened. Still thinks it's possible. China's cut interest rates and there are other measures to come to stimulate that economy. They do need to stimulate the economy, which would in turn drive the resource-centric Canadian economy.

Preferred share market has been under a lot of pressure, very volatile. Tends to trade with the broad markets. When there's tension in the broad markets, the reaction of preferred shares is heavier because it's a thin market. Retail investors unloading at tax-loss selling season can drive real price dysfunction in that market, which is unfortunate.

The market's only going to get smaller, as a number of the big banks have redeemed their preferreds and are shifting over to hybrids and other methods of funding. You can get a fixed rate or a floating rate (rate reset) type. He likes rate resets when rates are going higher, as the preferred shares will reset to a spread above the BOC rate. 

From this level, we could see a little bit of capital appreciation. It really depends on the type you have, and you have to really be aware of the different features of each.