Dear client,
It’s been a hectic few weeks since my last memo. Summer pretty much ended suddenly in Montreal with fall fast approaching and my weeks in Maine seemingly very far away…
The first six months of 2022 were very difficult, and by the end of June, almost 100% of the experts were predicting a rotten summer for the financial markets. However July 2022 turned out to be an excellent month that no one saw coming. Just as commentators started to claim the worst was behind us, it all went downhill again. According to the CNN Business Fear & Greed Index, we are currently in a time of extreme fear.
I don't blame investors for this state of mind. 2022 is truly, so far, a rotten year! The table below demonstrates this well.
The red dot is 2022 so far. On the x-axis, which is horizontal, you find the performance of the S&P 500. On the y-axis, which is vertical, you find the performance of 10-year US Treasury bonds. Be careful, not the interest rate, but the total performance of such a bond. We can clearly see that 2022 is the worst year when we take into account the two major asset classes (equities and bonds).
In our last deep bear markets (2000/02, 2008/09 and 2020), equities were falling but this was offset by the positive performance of bonds. This is not the case today. In fact, it's the worst bond market since 1845 according to the Wall Street Journal (It's the Worst Bond Market Since 1842. That's the Good News, 6 May 2022) and certainly the worst since World War II. The table below is eloquent.
When we take into account the two asset classes in a classic balanced scenario, say 60% in equities and 40% in bonds, we arrive with one of the three worst scenarios since 1945. Only 1974 and 2008 compares. This shows how difficult 2022 has been. (See table below). Therefore you are right to find this year difficult in terms of portfolio returns.
Nevertheless in this bad news (which you probably felt intuitively) there is light at the end of the tunnel. That light is that we survived 2008 and 1974. Investors who remained calm during those bear markets had very good years afterwards. In particular, 1975 and 2009 were boom years in terms of stock market returns (+37.20% and +26.46% respectively).
In our case, we continue to emphasize our investment methodology. For each company, we study the income statement, balance sheet and cash flows over several years. We analyze several aspects, including margins, revenue and profit growth, leverage, balance sheet structure, return on equity, etc. Then we do a thesis on the competitiveness of the company. In other words, will they be able to defend their market and make it grow? The source of each company's competitiveness is different. Sometimes it's technological (like for Alphabet or ALSM), marketing/branding (like for LVMH or Estee Lauder), geographic (like for CP), managerial (like for Intact, Brookfield or Toromont). Finally, we ask ourselves the question, how much is a company, that has the financial and competitive attributes that we are looking for, worth?
The result is a collection of companies in 10 economic sectors, 7 countries and of very different sizes (from Uni-Select to Apple). Most of them pay a dividend (in the Global Income, only one security pays no dividend, while in the Global 35, seven securities do not pay a dividend). Some have significant debt (Fortis and Brookfield for example), others do not (Meta, Westshore and Novo Nordisk to name a few).
Each one of them will weather the storm we are living in, regardless of a potential US recession. I say potential, because despite the predictions, some voices are arguing that it’s not a forgone conclusion, including Susan Collins, president of the Boston Fed or even JP Morgan Economic.
Take one of the securities I recently acquired for you (February 2022), ASML Holding NV.
It is a company based in the Netherlands that develops and markets photolithography machines for the semiconductor industry.
My timing was rotten, to say the least. We've been down 35% since! But over the past 10 years, ASML has had sales growth of 12.7%/year, profit growth of 15%/year, and dividend growth of 25%/year. With very little debt and a booming market (which includes cloud computing, 5G, artificial intelligence and vehicle electrification to name a few), ASML is a stock that does not worry us, even in the storm that we are living.
The other good news is that each bond renewal we make has a much better rate of return than 12 months ago. If, in addition, we consider that we can renew bonds at a discount, this means that you receive interest and a capital gain at maturity. The combination of the two makes the overall yield particularly attractive.
Take the following example.
Yesterday, we could buy a BMO bond maturing on July 29, 2024 (so just under 2 years). It was trading at $95.42 and paying a coupon of 2.28%, or remember $2.28.Your yield at maturity (i.e. the coupon plus the $4.58 discount to be received at maturity) was then 4.92%. In this return, there is interest (the coupon) and capital gain. It's not the same tax treatment at all. Net of tax, this is a return of 3%. However, to have this net return on a GIC, you would need a taxable equivalent yield of 6.44%. For a BMO bond less than 2 years old. This is a VERY good return with little risk.
In closing and not wanting to sound like a broken record, I sincerely believe that at this stage, patience is imperative. We are currently in a real financial storm but we have the portfolios to successfully navigate to our destination. As usual, if you also have a logical and realistic financial plan, there is nothing to worry about. Furthermore, if you have excess cash, it's a good time to invest.
I encourage you to come see us at Place Ville-Marie, to call us or even introduce us to the people you love and who could benefit from our advice in these trying times.
Best regards and hoping to see you soon,
Charles F. Lasnier, MBA - CIM