Investment Environment - Fall 2017

Jul 04, 2018 | Mark Lloyd


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Our typical client portfolio has earned an 11% rate-of-return over the last five-year period. But eight years into a bull market, are we not overdue for a correction? How we answer this question depends on how we foresee the future of interest rates

Stock prices resumed their broad march higher as retail brokers and institutional investors returned to their desks after the summer hiatus. Anticipation of enormous corporate tax cuts in the United States is the ostensible reason for the rally. Our portfolio values continue to set new highs in terms of market valuation. In fact, our typical client portfolio has earned an 11% rate-of-return over the last five-year period. But eight years into a bull market, are we not overdue for a correction?

How we answer this question depends on how we foresee the future of interest rates. I have long observed in these reports to clients that the extreme low interest rates we see today are unnatural. That has not stopped central bankers of governments around the world from enforcing them. Although central bankers say they want to “normalize” (i.e., raise) interest rates, many practical barriers stand in the way. To date, the economy has not grown fast enough to raise rates without the risk of encouraging recession. In addition, government debt levels are so high that “normalized” interest rate levels could cause a fiscal crisis. Meanwhile, each individual nation has an incentive to stick to low rates, since to raise rates is to strengthen one’s currency, which undermines the competitiveness of one’s export economy.

Until significant interest rate hikes occur, the buoyancy of prices in equity markets is likely to persist. For example, consider the stock of Canadian pipeline and utility giant, Enbridge (ENB.TO). At $47, the stock pays a dividend yield of 5.2%, while exhibiting numerous safety features due to the regulated nature of the business, the high barriers to entry, and the long-term visibility of cash flows. Darryl McCoubrey (our trusty analyst of utilities and pipelines at independent research firm, Veritas) insists that Enbridge is worth $65. In the absence of rapidly rising interest rates, it is difficult to envision significant downside for this investment. Likewise, stocks with impressive growth characteristics will continue to command premium valuations. Investors will be willing to pay up for wealth-creating profit growers in a world where the cost of capital (measured by interest rates) remains low. Our U.S. equity holdings are weighted toward such fast growers.

Any expression of optimism regarding stock prices should to be offset with an expression of caution. It has been many years since we have experienced a meaningful stock price correction, and this can lead to a dangerous sense of complacence about risk. I try always to own investments that I am comfortable will weather an unexpected season of financial market volatility. Your portfolio expresses my ongoing attempt to balance opportunism with capital preservation.

Mark Lloyd, Ph.D.

Vice President & Portfolio Manager

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