Stan Wong, portfolio manager at Scotia Wealth Management
FOCUS: North American large caps and ETFs
With US inflation hitting a 40-year high of 8.6 per cent in the twelve months through May, equity market volatility continues to be significantly elevated. The S&P 500 Index, Nasdaq Composite Index and MSCI World Index have all slipped into a technical bear market. Year-to-date, the energy sector has been the only positive performing sector advancing by over 25 per cent in most major markets. To dampen inflation, the Federal Reserve last week raised its benchmark interest rate by 75 basis points – its most aggressive single rate hike in nearly 27 years. Unquestionably, the combination of high inflation and hawkish central banks around the world has compelled many market participants to consider the possibility of a looming economic recession.
Given the recent price action and various sentiment indicators, the market appears to have decidedly priced in an economic recession. From a fundamental perspective, valuations have fallen meaningfully with the S&P 500 Index now trading at 16x forward price-to-earnings. From a technical view, stocks are oversold with most major markets trading down to key relative strength index (RSI) levels. Overall market breadth is particularly weak with only 5 per cent of the S&P 500 Index’s constituents trading above their 50-day moving average and only 15 per cent above their 200-day moving average. Often considered the market’s fear gauge, the CBOE Volatility Index (VIX) has risen to critical levels. As well, the American Association of Individual Investors (AAII) bearish sentiment reading recently hit a 10-year high, surpassing March 2020 levels.
Notwithstanding the gloomy mood of the markets and the challenging economic climate, we see opportunity as investor emotions veer to fear and panic. As always, we encourage investors to heed the old investment aphorism “be fearful when others are greedy and greedy when others are fearful.” Undoubtedly, the greatest opportunities are found during the most uncomfortable and unsettling times. To be clear, we view bear markets as periods of tremendous opportunity for prudent investors looking beyond the uncertainties of the near-term time horizon. The eventual easing of supply chain pressures and cooler inflation data should act as a catalyst for a meaningful equity market recovery. Already, we have seen core CPI (CPI ex- food and energy) inflation tick downwards over the past two readings. As well, the upcoming US midterm elections are looking like they will result in a more corporate-friendly Congress.
In Stan Wong Managed Portfolios, we have tilted our allocation to value stocks and have reduced our weighting in growth stocks. The financial, energy, materials and health care sectors look particularly attractive to us. We remain cautious on the technology sector (and other higher multiple growth areas) given the rising interest rate environment and relative valuations. The S&P 500 Information Technology Index recently traded at a valuation high of 7.8x price-to-sales in December (now at 5.3x price-to-sales). In March 2000, the technology index reached a price-to-sales multiple highs of 7.5x before falling 82 per cent over the next 30 months. From a geographic perspective, we like US equity markets for its breadth and depth of high-quality names while Canada looks attractive given its relative valuation discount. In our fixed income allocation, we are underweighting government bonds in favor of inflation-protected bonds and short-duration corporate bonds.
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COSTCO WHOLESALE (COST NASD)
Last bought this month at ~US$450
With over 116 million members around the world and over US$225 billion in expected revenue for 2022, Costco is a dominant name in the mass merchant space. Costco continues to enjoy tremendously strong loyalty in the US and Canada with membership renewal rates steady at about 92 per cent. Among mass merchant retailers, Costco is a clear leader in cost leverage, procurement strength and store efficiency – allowing for store traffic to remain exceptionally high. Despite the large size of its warehouses, the company concentrates its buying power on a relatively small number of items (about 4,000 units in-store compared to 140,000 units at Walmart superstores). Amid rising fuel costs and inflationary pressures, Costco’s value proposition continues to grow more attractive for its members. The company reports its next quarterly results on Sept. 22, 2022.
ISHARES S&P/TSX COMPOSITE HIGH DIVIDEND INDEX ETF (XEI TSX)
Last bought this month at ~$25
The iShares S&P/TSX Composite High Dividend Index ETF is designed to replicate the performance of the S&P/TSX Equity Income Index. The XEI ETF provides a compiling opportunity for investors seeking strong dividend income from established, large-cap Canadian companies. XEI currently pays a 3.9 per cent dividend yield with top holdings in Canadian banks, pipelines, utilities and telecommunications. With the iShares S&P/TSX Composite High Dividend Index ETF still down over 12 per cent over the past two months, this provides an attractive buying opportunity for high-quality Canadian dividend payers. The ETF carries an expense ratio of 22bps.
SHELL PLC (SHEL NYSE)
Last bought this month at ~US$50
Shell PLC is one of the world’s largest integrated oil and gas companies with some of the most attractive assets in the global energy sector – notably the world’s largest liquefied natural gas (LNG) business and the largest chain of fuel stations. Shell’s enormous global reach spans across more than 70 countries. Last month, the company reported its highest quarterly profit ($9.1 billion) since 2008 and announced plans to increase its dividend. Shell could meaningfully increase its dividend in the coming quarters given its conservative dividend payout ratio of 20 per cent. Shell is also currently back an $8.5 billion share buy program this year. As one of the chief LNG players in the world, Shell stands to benefit from the rise in global gas demand and stronger prices over the next decade. The shares yield a 3.9 per cent dividend and trade at only 5.3x projected earnings. The company reports its next quarterly results on July 28, 2022.
PAST PICKS: June 24, 2021
CONOCOPHILLIPS (COP NYSE)
- Then: $61.39
- Now: $92.92
- Return: 51%
- Total Return: 55%
UNITEDHEALTH GROUP (UNH NYSE)
- Then: $398.87
- Now: $499.88
- Return: 25%
- Total Return: 27%
ISHARES GLOBAL FINANCIALS ETF (IXG NYSE)
- Then: $77.90
- Now: $65.49
- Return: -16%
- Total Return: -13%
Total Return Average: 23%