It may take being a bit of a contrarian to capitalize on opportunities in the current market environment
Published Apr 24, 2023 • Last updated 1 day ago • 3 minute read
Traders work on the floor of the New York Stock Exchange. Photo by ANGELA WEISS/AFP via Getty Images files For those wondering about what’s in store for the markets, pundits seem to be lining up their bets based on three outcomes: a soft economic landing resulting in flat-to-moderating interest rates; a soft economic landing paired with deflation and much lower interest rates; or a deeper recession with much lower interest rates.
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Access articles from across Canada with one account. Share your thoughts and join the conversation in the comments. Enjoy additional articles per month. Get email updates from your favourite authors. There is a clear division in opinions about these scenarios among investors. Some stock investors have recently been herding into long-duration, large-cap tech stocks based on the second scenario, while others have been selling the rest of the S&P 500 based on the third scenario. Bond investors, for the most part, seem to be positioned according to the first scenario.
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The S&P 500 is down 5.5 per cent over the past 12 months, which lines up with the blended 4.8 per cent drop in earnings growth, and the 6.2 per cent drop after taking out energy stocks, according to Refinitiv Ltd.’s first-quarter data.
However, the 12-month forward earnings-per-share estimate for the S&P 500 ranges from a six-per-cent to a nine-per-cent contraction, half of what typically happens during a recession. At the same time, the spread between the S&P 500 earnings’ yield and three-month U.S. Treasury yield remains negative, and is now at its lowest since early 2001.
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Article content Making a call even tougher is that we keep getting conflicting economic data. First-quarter U.S. consumer spending was up nine per cent year over year, according to Bank of America Corp. data. This makes sense as the expectation is for a whopping first-quarter earnings growth figure of 36.5 per cent among U.S. consumer discretionary sector companies, according to Refinitiv data.
But credit tightening from U.S. banks could have an impact, along with interest rates staying higher for longer. Meanwhile, the ISM manufacturing index has remained in negative territory for the fourth straight month.
What’s an investor to do in the midst of this uncertainty?
Well, many are parking their funds in high-interest savings accounts and exchange-traded funds. Cash alternatives now account for 18 per cent of the entire fixed-income market in Canada, according to National Bank.
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Article content We can’t blame investors for doing so since getting more than five per cent seems like a good safe trade. We have 10 per cent of our balanced fund in these Canadian high-interest vehicles offsetting our low 10-per-cent bond weighting, mostly in U.S.-dollar-denominated floating-rate bonds.
Balancing this out is our 45-per-cent weighting in global equities. We think chasing long duration in both bonds and stocks on the assumption that we’re going back to pre-2022 conditions is a risky trade, especially should the global economy beat expectations and interest rates remain at or near current levels — the most likely scenario, in our opinion.
This means we are favouring global value instead of growth, and small and mid-cap stock instead of large cap. In the event we are wrong, we still have some exposure to U.S. tech via the S&P 500, which is heavily concentrated in this sector.
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Article content We also still like energy in this type of environment because we think many are being too pessimistic in their outlooks for oil demand given the backdrop of rapidly falling global inventories and supply constraints.
Stop emotions from messing up your investments 3 specialized vehicles to keep 60/40 investors happier Finding good companies is like finding an affordable home Furthermore, we have a 30-to-35-per-cent weighting in structured notes. For example, we just did a note that will pay a 12.25-per-cent coupon if the S&P/TSX composite closes above zero per cent in 12 months. If not, it rolls over to next year for a 24.5-per-cent coupon if the index is above zero per cent.
We did another one on a Canadian-dollar-hedged S&P 500 with an annualized 9.25-per-cent coupon that is paid out monthly as long as the index doesn’t fall more than 30 per cent from current levels.
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Instead of going all in on some economic scenario, take a diversified approach with tilts towards those areas of the market that will maximize the probability of achieving your goals. This may mean not tracking the hottest segments du jour, but doing your own thing. The good news is that there are plenty of opportunities in the current market environment, but it may take being a bit of a contrarian to capitalize on them.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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