David Driscoll, president and CEO of Liberty International Investment Management
Focus: Global equities

MARKET OUTLOOK

While some market analysts make the statement that the majority of this quarter’s earnings are positive, we disagree. We believe the S&P 500 Index is not trading at 19.21 times earnings but more like 21.79 times earnings, a 14-per-cent difference or overstatement.

We believe companies are using smoke and mirrors to fudge their earnings in three ways:

1. They’ve talked down expectations so they don’t have as much ground to make up.
2. They’re buying back shares in record amounts to ensure they show earnings “growth.” For example, Bank of America earnings were up 8 per cent in the last quarter, but if not for the share buybacks, there would have been little to no profit growth.
3. Companies have reduced their capital expenditures, which has reduced their costs and pumped up earnings. Unfortunately, by not investing in capex, these firms are sacrificing the future for the present.

Our S&P Index ranges remain 3,700 on the high side and 2,200 on the downside. In the event of a “melt up” rally of 20 per cent, market valuations would be similar to the 1929 and 2000 peaks. If the S&P drops from 3,700 to 2,200, the difference would be 40 per cent on the downside. This is not a good risk/reward ratio to have. If you take $1 and go up 20 per cent and then drop 40 per cent, you’ll be left with 72 cents, not the original $1. And similar to 2008, it may take four to five years to get back to break-even. That could put retirements in jeopardy or those preparing to retire as nest eggs would be much lower and why we believe it’s important to hold some cash in the portfolio, be diversified globally and avoid correlation risk and concentration risk.

TOP PICKS

CHUBB (CB.N)
Last purchased on July 23, 2019 at $145.98.

Chubb is a global property and casualty insurance company with subsidiaries in 55 nations. The best metrics to study for the insurance industry is book value growth and combined ratios. Year-to-date, net tangible book value is up 12 per cent, while the combined ratio is 89 per cent (89 cents of costs versus $1 of premiums written). Their entire investment portfolio of US$107 billion is made up of investment-grade bonds and cash, so if interest rates continue to fall, the value of the investment portfolio should grow.

BROOKFIELD ASSET MANAGEMENT (BAMa.TO)
Last purchased on July 23, 2019 at $63.36.

Brookfield invests in real estate, power-generation assets and infrastructure holdings. An investment in Brookfield is to take advantage of long-duration assets that should provide sustainable returns while management fee income from its private equity pools enhances overall total returns. It’s also a quasi-hedge. If economic growth collapses, Brookfield, compared to other publicly-listed corporations, should be sheltered from an earnings collapse.

TREASURY INFLATION-PROTECTED BONDS (TII 2.125% due Feb. 15, 2040)
Last purchased on July 24^th, 2019 at $128.95

The Treasury inflation-protected bonds are another way to hedge against falling interest rates. Long-dated bonds have the greatest price sensitivity and rise the most in price when interest rates drop. An investor receives the 2.125 per cent coupon every year plus the inflation rate (currently 1.65 per cent) for a total coupon of 3.775 per cent. Add in the price return of 10.3 per cent and the total return year-to-date is 14.08 per cent in U.S. dollars. If the U.S. government continues to raise budgets and increase its deficit spending while wages continue to move higher, inflation could rise.

PAST PICKS: OCT. 12, 2018

A.O. SMITH (AOS.N)

• Then: $47.76
• Now: $43.74
• Return: -8%
• Total return: -7%

STERIS PLC (STE.N)

• Then: $106.10
• Now: $147.89
• Return: 39%
• Total return: 41%

CHUBB LTD. (CB.N)

• Then: $126.25
• Now: $152.27
• Return: 21%
• Total return: 23%

Total return average: 19%