Long Weekend Read: Back to the Basics

August 01, 2021 | Richard So


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3 factors to help ride out volatility

Long weekends over the summer are precious and to be able to enjoy one under a provincial stage 3 re-opening phase will be that much more delightful. We hope that our readers and clients will have a safe and enjoyable Civic holiday. Over the last week, it has been heartwarming to hear our clients’ plans to visit and give hugs to family and friends. Sixteen months into a pandemic, something as basic as a hug has become momentous.

As my youngest son tells me, ‘the best part of a hug, is the squeeze’. And so, as financial advisors, we formally recommend you to give the biggest squeeze!

In this post, we are inspired to go back to the basics. What are three key market fundamentals that continue to support our constructive view of markets? Below we highlight 3 three: earnings, yield curves and cash.

An Earnings Bonanaza

The current earnings season has been fantastic. As seen in the table on the left, 88% of companies that have so far reported have beaten expectations. Notably, the amount they have beat expectations (aka. “earnings surprise”) has been unprecedented at 20.8%. Given that the average earnings surprise over the last 5 years had been around 4-5%, this hints that analysts may need to raise future earnings expectations which would allow market prices to rise without expanding the forward P/E multiple. In other words, prices can rise with less fear of a bubble forming.

Also of note is the "Year-over-Year Earnings per Share Growth" from the table on the right. One can see that earnings are expected to grow the fastest for the cyclical sectors and much larger than the technology sector. Despite the recent underperformance of cyclical and “economic reopening stocks”, this lends us to continue to prefer a balanced approach that includes both cyclical and technology.

Really Negative Real Yields

Real Yields measure the amount of return one receives after taking inflation into consideration. After an initial move higher in yields in the spring, they have quickly come back down to earth to reflect the uncertainty surrounding the delta variant.  The result has been that real yields are deeply negative across the entire curve in the U.S., with the Canadian curve barely above zero on the long end. This means that a Canadian investor who buys a 30-year real return bond would be guaranteed to earn just 0.06% per year in terms of purchasing power. In the U.S., it would guarantee a 0.36% annual loss in purchasing power over the next three decades. Needless to say these are not particularly attractive propositions and therefore we believe investors may continue to look at equity markets for income and growth.

It's all about the Benjamins

 

As we mentioned in last week’s blog, daily covid cases in the US are expected to rise to over 100,000 in the coming weeks. The surge in delta lasted 45-50 days in countries like the UK and India, and therefore it could be another few weeks before the US reaches its breaking point. Hence, volatility is expected. What gives us comfort is the ample amounts of cash on the sidelines. The chart above shows the near-record amount of money market assets (aka. cash equivalents) being held by investors. At nearly $4.5trillion, this could provide the dry powder to help support periods of market nervousness and uncertainty.

These are a few fundamentals that the team finds invaluable to help clients regain perspective during what was a noisy month of July and what is expected to be an equally challenging August. Whatever the market brings in the future we are committed to walking and guiding our clients through it. In the meantime, we hope that over this weekend you might enjoy the extra day off to take a break and to give a big hug.

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