Are Stocks Expensive?
If you are talking the Nasdaq U.S. market, the answer is yes. If you are talking the S&P500 U.S. market, the answer is probably yes. If you are talking other markets, then the answer may be no.
One measure of valuation is the Forward Price/Earnings multiple, or P/E multiple. The higher the number, the more expensive the market.
The S&P500 is at 21.3.
The Nasdaq is at 24.6.
In comparison, the Canadian TSX Composite is only at 14.9.
The British FTSE100 index is at 12.4.
The broader Euro Stoxx index is at 15.5.
The Emerging Market index is at 12.5.
Of interest, the TSX has a lower Forward P/E at the moment than it has had for most of the past 3 years.
Another view of the U.S. large cap S&P500 is what is known as the Shiller PE ratio. This is a different way of measuring valuation. The Shiller PE is currently at 38.6, which is considered 49% higher than the 20 year average, and very close to the 20 year high.
What Sectors are Less Expensive that we like?
While the process is definitely not as simple as more expensive and less expensive, it should be noted that the five least expensive sectors are Financial Services, Energy, Consumer Defensive, Utilities and Industrials. The most expensive are Consumer Cyclicals, Real Estate and Technology.
In an environment of rising interest rates and inflation, we continue to like Financial Services, Energy, and Industrials. These are sectors that should also see some benefits from increased infrastructure spending.
While we are not making significant Geographic shifts, we are very focused on avoiding too much exposure to sectors that we deem expensive and more heavily impacted by interest rate hikes.
Where do dividends fit in?
According to the Hartford Funds, dividend income’s contribution to the total return of the S&P 500 Index averaged 41% from 1930–2020. Clearly dividends matter.
At a time when bond yields are lower than inflation, there is a greater demand for stocks that can pay a higher dividend. Of course, that doesn’t even include the benefit of owning Canadian Dividends in a taxable account – which has a much lower tax rate than interest income.
In summary, we like dividend growers with good balanced sheets, we will lean a little more heavily here in 2022.
TriDelta Equity Funds
In 2021, our TriDelta Growth Fund had a return of 28.5%. This outperformed our equity benchmark of 23.2%.
The Growth Fund is an active fund that looks to adjust its approach throughout the year to be properly positioned for where we see the market today. We use quantitative analysis as the foundation along with a historical review of how market sectors reacted previously to similar market environments.
Our TriDelta Pension Fund had a return of 16.4%. While not as strong as the Growth Fund, this fund has a different mandate. Also using quantitative analysis as a foundation, we focus very much on balance sheet strength, and on long term dividend growers. This approach aims at less variability, downside risk and higher dividend yields.
The Bond Market is difficult in this environment
Financial heavyweight Citi says that bonds Globally will return negative 1% to 0% in 2022. This asset class is broad enough to find some winners, but the core vanilla bond space will find it hard to deliver returns with a combination of low yields and rising interest rates.
Where we own bonds, we are leaning shorter term, as they will provide some protection as the market is pricing in too many rate hikes. What we mean by this is that the market is now pricing in nearly 6 hikes over the next year. We do not see anything near that happening. It still means rates are going up, but not nearly as much as some think it might.
We do believe that there will be some tactical opportunities here in “next-best” companies like the Rogers/Shaw deal. Sometimes M&A activity can lead to opportunities. We would expect more leverage as companies try to borrow as much cheap money as they can, while they can.
Bonds are not cheap but most things are not either, so selective and tactical is our approach.
The Preferred Share Market has fewer opportunities than 2021
Fixed Rate or straight preferred shares are bumping up against a ceiling for enhanced returns. Many are yielding decent dividends in the 4.5% to 5.25% range today, but have prices at or above $25, with the risk of being called at $25. This doesn’t mean it is a bad place to invest, but the very strong returns from 2021 be very unlikely to be repeated in 2022. In 2021, Rate Reset preferred shares saw returns of 29.5%, while straight preferreds had a 9.2% return. While the 9.2% number pales in comparison, it was still a very solid return for this asset class. We still see some good opportunities in rate resets but expect both of those return numbers to be meaningfully lower.
One of the challenges in the preferred share market is that the market is shrinking as banks and some oil and gas names redeem issues in favour of cheaper financing via specialized bonds. What this means is that investors have to put a premium on the surviving issues, pushing their valuations into and often above their redemption prices. This is a sector of the market where understanding the details of the company, their capital requirements and the specific terms of a preferred share is extremely important. It can add meaningful value to buy specific securities vs. the index and some ETFs (although ETFs can be of value for smaller transactions).
Relatively speaking, resets and floaters (this is a pretty small market in Canada) enter the year as a better value than straights due to the rising rate outlook. We would be looking to avoid reset and floater issues with large reset spreads and approaching reset dates. They are likely to be called and are probably trading at a premium to redemption price. For now, non-bank and non-oil and gas prefs are less likely to be redeemed as issuers have fewer refinancing options and should be safer places to invest.
We will continue to buy straights on dips, especially when rates are moving in a volatile fashion to the upside. Barring an inflationary mistake, the rate hiking cycle will be a short and small one.
Inflation will be high for the short term, but should come down later in the year and early 2023
Inflation will remain in the mid single digits for much of the year, 4-5%, give or take, but may weaken late in the year. Whether it is COVID restrictions, sustainability compliance efforts, speculation in commodities, low unemployment or consolidation-induced pricing power, there will be pricing pressures through 2022, but below peak levels seen in 2021.
Alternative Income Strategies – Most are performing well
While Bridging Finance was the big story in this space in 2021, the rest of the industry continued to deliver solid gains.
Alternative Real Estate funds had a good year, with our top fund returning over 26%.
Mortgage funds continued to perform, with returns in the 6% to 9% range.
Our top Private Debt funds should end the full year in the 11% range, with others solidly in the 7% to 8.5% range.
As greater transparency and valuation standards are in place, we continue to see this sector of investing as a key part of most investors portfolios.
This data tells a very important and clear story. Big pullbacks represent good entry points. As I write this, the S&P 500 has crossed the 15 per cent line from peak to trough this month.
New Flyer Industries is a Winnipeg-based company that manufactures and services transit buses and motor coaches. The stock was down 42 per cent in 2018 and down 25 per cent in the final three months of the year. Today it trades at around $34 a share, has a dividend yield of 4.5 per cent, and is trading at 8.8 times its forward earnings — a significant discount to its long-term average. During the terrible returns for the stock in 2018 it has seen its earnings continue to grow, as it has for the past six years. It is very integrated in both Canada and the U.S., and while there were some worries about how NAFTA would impact operations it looks fairly positive at this point. Today it is simply a great deal.
A final note on asset mix. We believe that if your asset mix was right for you 6 months ago, it is probably still correct for you today. The only reason for a meaningful change is if your cash flow needs have changed significantly or if your overall financial position has had a meaningful change. If those haven’t happened, we wouldn’t recommend changing now. Keep in mind that in February 2009 it was almost impossible to get people to invest in the market – with most late RRSP contributions going to cash. For the full year 2009, the TSX had a return of 35.1%. The point is that it is very difficult to pick a market bottom, but we do believe it isn’t far off from here. When the bottom hits after a sudden pullback, there is quite often a very strong rally. Investors with a long term perspective do not want to miss that rally.
Since equities are public companies, typically when inflation rises, these companies find ways to continue generating higher profits by raising prices and /or cutting costs. E.g. if inflation rises, Walmart, McDonald’s, Royal Bank and TransCanada Pipelines typically find ways to continue increasing profits (and potentially dividend payments to shareholders) through changes in pricing or cost cutting measures, thereby protecting the investor’s purchasing power.
