Investment Environment - Summer 2017

Jun 25, 2018 | Mark Lloyd


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For years, I have been content to overweight equities but to concentrate on lower risk sectors like consumer staples, utilities and real estate (REITs). As “low volatility” stocks have become more popular, this strategy has become stale.

The beginning of the Donald Trump era has been favorable to the bottom lines of my clients’ portfolios. Even with the S&P/TSX Composite Index return stuck at zero, most balanced portfolios in my book are up more than 6% in the first half of 2017. While I expect the second half of the year to be more challenging to navigate, I do have a plan to combine opportunism with capital preservation.

Of real concern today are the attempts of the U.S. central bank to raise interest rates -- even in the face of sluggish growth, wage stagnation, and below target rates of consumer inflation. Although the economy does not appear to require interest rate tightening, the Fed wants to raise rates so that it will be able to lower them when the next recession hits. If the economy should weaken and consumer prices remain soft, then the Fed will have to reverse course (as they did in 2015).

A kind of inflation is occurring presently in asset prices (as anyone shopping for real estate in the GTA is painfully aware). Stock prices are very elevated, if not to the extent of Canadian residential real-estate prices. Equities on the U.S. household balance sheet command a 24% share of total household assets, a level that was only surpassed in the dotcom era of the late 1990s. I am under no illusion that stock prices are cheap at today’s levels. It is getting harder to find cheap stocks to buy.

Because the future is a closed book, we must position our portfolios to weather a range of different economic and financial market outcomes over the next 12-18 months. For years, I have been content to overweight equities but to concentrate on lower risk sectors like consumer staples, utilities and real estate (REITs). As “low volatility” stocks have become more popular, this strategy has become stale. I now look to balance stocks that will outperform in a rising interest-rate environment (Manulife, Blackstone Mortgage Trust) with securities that will outperform in a falling interest-rate environment (high dividend stocks, long-dated U.S. treasuries). This “barbell” approach to balancing risk is combined with individual stock selection that seeks to capitalize on special situations. Rigorous independent research from Veritas (Canada) and Grant’s Interest Rate Observer (U.S. & Global) continues to provide a steady stream of actionable and profitable investment ideas.

The strong returns we’ve achieved this year are the product of flexible-minded opportunism combined with steadfast risk management. Nothing pleases me more than when we can make forward progress in a flat or negative market environment.

 

 

 

Mark Lloyd, Ph.D.

Vice President & Portfolio Manager

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