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

Economy.Government, corporate, nonfinancial and consumer debt has been rising as a percentage of global GDP. Even after years of austerity programs, we are in a situation where the global debt level has been rising, and suddenly we are at an inflection point where interest rates are starting to pick up. This is going to have an impact globally. Bond yields are starting to rise around the world. Central Banks are not raising rates in Europe or Japan anytime soon, but we are starting to see a bit of an uptick in bond yields, which is going to impact over time on mortgage borrowers and government bond issuers. Everyone is going to be following the Fed and the Bank of Canada, and there is the usual lag, so he figures that in the next 24 months we are going to start seeing rates coming up in other parts of the world. In a rising rate environment, you want to avoid some of the overvalued sectors, specifically pipelines and utilities. Investors have been buying those and driving up valuations on companies that have minimal growth. They are buying them for the dividend yield. You want to be in really strong undervalued companies, and not just riding yesterday’s winners.

A high dividend paying stock? Buying the stock just because it pays a high dividend is not a good reason. In a rising rate environment, those dividends become less attractive. When you buy a stock, buy a company because you think the stock is undervalued. He likes the Cdn insurance companies because you are going to have a rising dividend over time. (See Top Picks.)

Buy US$ now or wait a month or 2?Has never met anyone in the investment business who has predicted correctly the direction of the Cdn$ versus the US$. If you have to buy US$, either buy it all now because the Cdn$ has rallied, or buy half a position, but don’t try to think you will be able to guess the direction. That always comes back to bite people.

Market. Usually, from about Nov 15 to the end of the year the market does well. From here to Nov 15, it is usually flat and then up into the year end, so maybe there won’t be any correction until early next year. Surprised energy is not doing better with oil prices of $51-$52. Stocks had a nice run when oil initially pushed through $50, but it hasn’t really followed through, even though it has tried a couple of times. Fears of a bubble in Canadian real property has kind of dissipated. In the banks, the quarter was up about 9%, dividend increases were still there, and we now have reasonable returns, so it’s a nice place to hide.

Black Swan? By definition, an upcoming recession is probably not a Black Swan. Usually there is so much debt that you get out on a limb. Other than real estate, we don’t seem to have any thing else that feels like a bubble. We have an expensive market, but we don’t have an inverted yield curve or anything coming, except the pace of higher rates. If there is some danger of the Fed tightening too quickly and tip us over into a recession, that would be 2 years from now, so the earliest risk would be 2019.

Market.We are now starting to get economic data that suggests the consumer is not quite as robust as they once were. Today the August retail sales report came out, which is consumer spending. It fell .3% after a .4% gain in July, and excludes cars and auto parts, which are more volatile, so we are looking at core consumer spending, which actually fell .7%. In July it was up .2%. The economy is taking a sharp turn for the worst. The economy has been carried by the consumer and the housing market for a long time. You would want to have a moderate housing correction, and hopefully energy exports can pick up. Maybe crude oil prices are stabilizing which would help. Our exports have been falling for 3 months in a row, and in those 3 months, we lost 10% of our exports. That is due to a very strong Cdn$ due to the 2 rapid rate hikes. Taking back the emergency rate cuts is totally justifiable, but doing that in a hurry will have a larger than expected impact. Element of surprise has always been the strongest tool in the Central Banks toolbox. He can’t see any reason for them to raise rates further.

Market. The average investor has a 30 year time frame. We have not had a correction in a very long time but if you are worried about it and you have a long timeframe, you don’t have to worry about it.

Central Banks.They are forward-looking, so monetary policy to some extent is forward-looking, considering that a lot of Central Banks in the US have hiked rates 3 times since Trump won the presidency. In Canada, the Bank of Canada has hiked rates twice, so we are forward-looking, because inflation isn’t quite at the target a lot of these Central Banks are targeting, which is 2% or below. They think the slack is eventually going to get absorbed and eventually move back up to 2%. Having fixed income in a portfolio is important, because it will act as a ballast and give you an opportunity to redeploy capital when an opportunity presents itself. As long as we have decent credit growth and decent economic growth, it bodes well for owning equities, corporate profits and earnings.

American Mortgage REITs?Typically very highly leveraged, which is one of the reasons he doesn’t own them. The perverse part about what is happening to rates is that the short end has gone up and the long end actually hasn’t. Where you want to start to get worried is when rates move up too quickly, which puts more of a dent in home ownership in the US.

Market. The 10-year chart for the S&P 500 is a thing of beauty. Trading at record levels. If looking at PEs vs estimates, there are people who will point out that the PE multiples have been moving higher, so prices are higher. Last quarter, 55% of companies beat the estimates, so estimates are too low. That has been rising. PE multiples that people are looking at are probably making stocks look more expensive than they are. Secondly, we are in an extremely low interest rate environment, and PEs can be higher. We are in a secular bull market for equities. It didn’t start until 2013. When you took out the highs from the last bull market in 2000, that was the 1^st year of multiple expansion, and multiples have been expanding since. There will be corrections, but expects equities between 2013 and 2023 are probably in the teens from a return standpoint. The volatility we have been seeing, that everyone is saying is so low, is virtually identical to the early 90s and identical to the early 50s. Both were in secular bull markets. We will see a good-sized correction out there somewhere, but none of his work points to any of the things that would be happening if it were coming up soon. As long as the percentage of stocks performing well are expanding, there is no bear market or correction that has ever taken place while that is happening. The most important thing in the way a market is behaving, is how it reacts to news. For example, there have been lots of big news items last year and the market hasn’t cared.

Stop losses? He uses point and figure price charts, which mark out the orderly progress of either higher highs and higher lows, or lower lows and lower highs. He would encourage you to get a book on this. A very good one would be Tom Dorsey on point and figure charting. In the absence of that, for a longer-term investor, you could use a 150-day moving average. It is amazing how often a stock pulls back and then reverses higher at their 150-day moving average. If a stock dipped below this on heavy volume, that would be a good reason to become a seller.

Good stock or ETF for medical devices? He likes the area as a sector. If you check out iShares DJ Medical Devices ETF (IHI-N), it had a wonderful rally through 2016 into July 2017. Since then it has consolidated sideways, and is within a whisper of breaking out to a new high. The group is a little more economically sensitive than big Pharma, because more of these things are paid for by people who have more confidence to buy. You could also look at Stryker (SYK-N), which he owns, which manufactures hips and knees.

Market. The TSX has come roaring to life post labour day. Patience and diversification paid off. Stocks don’t go up in a straight line. Last year Canada was the star and this year, US stocks were the top of the leader board. He has mainly balanced portfolios. The round number fixation on 23k will get fixated on and this is nothing unexpected. It is probably not a reason to be nervous right now. Don’t try to pinpoint the top or bottom of a market but maintain a balanced portfolio. Fixed income has been sobering. The main benchmark index has been negative two quarters in a row. It is important for investors to realize that rising interest rates may dampen capital value of bonds, but it means when they renew, there are higher interest rates. The do have a place in a portfolio.

Utilities. He is not particularly favourable on utilities right now because we are in a rising interest rate environment. Utilities tend to suffer multiple compression in that kind of environment as they are a bond proxy.

Canadian Dollar vs. US Dollar. He won’t forecast the near term trend on the exchange rate. To protect a portfolio against a rising dollar is to run a balanced portfolio of Canadian and US equities as well as fixed income. If you are only considering Canadian companies than buy those that generate the majority of their revenue in the US. If you think the US dollar is going higher you want to underweight Gold and gold equities.