Jon Vialoux, research analyst and portfolio manager at CastleMoore Inc.
Focus: Technical analysis and seasonal investing

MARKET OUTLOOK

So much for “sell in May and go away.” The S&P 500 Index is now higher by around three per cent, including dividends, since the start of that month, already surpassing the average return typically achieved during the entire offseason for stocks that runs from the start of May to the end of October. Keep in mind that we are only halfway through this period and there’s still plenty of time for headwinds to emerge, but if they do they will be the result of fundamental factors driving the price action and not the calendar alone.

A number of factors have supported markets so far in this offseason for stocks. Of course, the prospect of a rate cut has reignited animal spirits as nobody wants to be caught betting against the Fed. Monetary accommodation not only creates greater liquidity, but it’s also conducive to improving valuation metrics of corporations given the decrease in the discount rate. Companies will often trade with a price multiple that’s higher than what it would typically be otherwise. At present, the forward price-to-earnings ratio of the S&P is 17.1, which is above both the five and 10-year averages of 16.5 and 14.8 respectively according to Factset. Forward earnings per share has yet to turn lower, implying that analysts still expect earnings to be upbeat over the next year. Whether the U.S. central bank is justified in providing further accommodation is up for debate.

The simple reason why a rate cut may not be justified is that economic data, on aggregate, remains solid. Employment continues to show above-average gains, retail sales just realized the best first half of the year performance on record, and core inflation metrics are trending above average. Two of these three components are in the Fed’s purview (employment and inflation), while the consumer is indirectly impacted by the prior two. It’s just the manufacturing economy that’s the laggard, unduly impacted by the ongoing tariff war, a self-inflicted wound that has hindered business activity for the past 18 months. Industrial production in the U.S. is up a mere 1.1 per cent through the first half of the year, less than half of the average increase of 3 per cent over this timeframe. Gauges of shipping activity have reacted accordingly ,with the CASS Freight Index showing the weakest growth in shipment activity since the last recession. Clearly, the leading implications of these metrics are not encouraging, which is why the Fed may feel pressured to be proactive to take measures now while they may still be effective as opposed to the start of a downturn when the momentum may be too significant to mitigate.

TOP PICKS

ISHARES EXPANDED TECH-SOFTWARE SECTOR ETF (IGV.O)

This ETF holds a basket of software equities trading on North American exchanges, including Microsoft, Oracle and Salesforce. The industry has been benefitting from positive year-over-year revenue growth and the more defensive characteristics of these technology companies tends to provide an ideal place to invest during the volatile summer period. Analysis of the S&P North American Technology Software Index shows that a buy date of July 31 and a sell date of Nov. 8 has resulted in a geometric average return of 4.2 per cent above the benchmark rate of the S&P 500 Total Return Index over the past 20 years. This seasonal timeframe has shown positive results compared to the benchmark in 17 of those periods.

BMO LOW VOLATILITY US EQUITY HEDGED TO CAD ETF (ZLH.TO)

The remainder of the third quarter is characterized as a period of increasing volatility and investors will want to find ways to hedge themselves. The BMO Low Volatility ETF provides exposure to a low beta weighted portfolio of U.S. stocks, providing less sensitivity to market movements. Reducing beta and correlation to the market in portfolios can allow investors to ride out the rocky trading period ahead, while still participating in the upside potential for stocks.

PURPOSE HIGH INTEREST SAVINGS ETF (PSA.TO)

With the period of seasonal volatility for equity markets, investors may be tempted to sell to cash to wait out the potential market storm. This ETF allows investors to park their unused funds while earning a stable return. The current yield is 2.15 per cent, with distributions occurring monthly. The fund invests in high interest deposit accounts with one or more Canadian chartered banks, providing investors with greater yield than traditional money market funds.

PAST PICKS: MAY 10, 2019

CME GROUP (CME.O)

• Then: $182.94
• Now: $194.93
• Return: 7%
• Total return: 7%

ISHARES EXPANDED TECH-SOFTWARE SECTOR ETF (IGV.O)

• Then: $215.59
• Now: $222.10
• Return: 3%
• Total return: 3%

LOCKHEED MARTIN CORP. (LMT.N)

• Then: $341.45
• Now: $361.92
• Return: 6%
• Total return: 7%

Total return average: 6%