Jon Vialoux's Top Picks: May 18, 2018

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

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MARKET OUTLOOK

DON’T BE SO SENSITIVE

Having just entered the historically weaker time of year for stocks between May and October, investors typically rotate to defensive areas of the market in order to hedge against equity market volatility. These areas include utilities, REITs and bonds, or the so called “yield sensitive” areas of the market. But with the economy showing the perfect setup for higher rates of inflation, investors may want to scrutinize their yield sensitivity within portfolios.

Looking at the consumer price index excluding food and energy from a non-seasonally adjusted perspective, the gauge of inflation is up by 1.4 per cent in just the first four months of the year, the second strongest start to the year in the past decade. Consumers are seeing prices rise at the fastest pace in years for categories ranging from household operations to personal care items. This doesn’t even include the impact of higher fuel costs. Fortunately, consumer spending has yet to realize any significant impact from these inflationary pressures.

One area is particularly vulnerable to inflationary pressures in the months ahead. Average hourly earnings of production and non-supervisory employees are trending well above average so far this year, on track to break the 2.6 per cent annual rate that analysts are closely monitoring. The number of open opportunities in the economy doesn’t help. A recent report on job openings and labor turnover indicates that openings are at the highest level on record, many of them found in the technology sector. A significant skills gap and an economy at full employment will force companies to pay more to attract the workers required to expand in this new tax era. 

These inflationary pressures, as long as they persist at the present rate, threaten to keep the U.S. Fed active in normalizing rates, thereby pressuring yields higher and taking a toll on treasury prices, quite possibly during the average period of strength for the asset class through the summer months. As a result, bond proxies are also vulnerable, warranting a review of portfolios for rate sensitivity at a time of year when these defensive bets have typically outperformed broader equity markets through the third quarter.

TOP PICKS

ISHARES U.S. HEALTHCARE PROVIDERS ETF (IHF.US)

Following a prolonged period of debate on how the Trump administration would address soaring drug prices, the recent proposals to increase competition in the pharmaceutical industry and promote transparency eliminates an overhang from the healthcare sector that’s persisted for some time. Various healthcare providers such as Aetna have already come out in support of the initiatives and the stock prices have responded accordingly. Seasonally, the industry benefits from strength between May 4 and Sept. 15, gaining an average of 6.64 per cent over the timeframe. The industry has outperformed the market in 14 of the past 18 seasonally strong periods. A reverse head-and-shoulders pattern on the chart of the ETF calculates an upside target towards $176.

POWERSHARES QQQ ETF (QQQ.OQ)

Tracking the Nasdaq 100, the ETF has been an effective way to gain diversified exposure to technology-oriented companies in the market. Many economic reports in the past couple of months have suggested growth in the technology sector that’s the best since the late 1990s amidst the tech boom. Computer and electronic product manufacturing is trending 3.9 per cent above average year-to-date, representing the second best performance since the year 2000. Information processing business equipment is trending 2.3 per cent above the seasonal norm. 

On the inflation side, consumer prices paid for computers through the first four months of the year showed an increase for only the second time in history, emphasizing the strong demand for product. The growth in orders for information technology industries are trending well above average as well. No matter what area of the economy you look at, the growth in the technology sector is beyond anything seen in the current century, as both consumers and businesses advance into this digital world. Seasonally, the NASDAQ 100 has averaged a gain of 5.26 per cent between April 15 and July 17. The benchmark has outperformed the S&P 500 Index in 14 of the past 20 periods.

BMO COVERED CALL DOW JONES INDUSTRIAL AVERAGE HEDGED TO CAD ETF (ZWA.TO)

This is a simple way of maintaining equity exposure during the volatile summer months. The ETF offers a covered call overlay to the well-known blue-chip benchmark, providing investors with an enhanced yield above that of the market. Coming into the more volatile time of year for stocks, investors will want to find ways to reduce risk and enhance yield in equity portfolios and this ETF is an ideal way to do that. The fund will provide continued participation to the ongoing positive trend in equity prices, but the benefits of the strategy really materialize in the flat-to-negative trending markets that are common between mid-July and early October. The ETF has a listed yield of 4.24 per cent, approximately 2 per cent above the yield of the Dow Jones Industrial Average.

PAST PICKS: SEPT. 29, 2017

RIO TINTO PLC (RIO.N)

Manufacturing activity in the U.S. has been showing some of the best performance in years and tax reform has added a catalyst to fuel the ongoing strength in this segment of the economy. As a result, manufacturers are buying materials for production at a rapid pace, providing a positive backdrop to commodity prices as well as the producers of them. What better way to play this favourable backdrop than investing in one of the world’s largest metals and mining companies? Over the past 20 years, shares of mining giant Rio Tinto have increased in value between Oct. 4 and Jan. 6 by an average of 10.76 per cent. Positive results were recorded in 15 of the past 20 periods. The stock broke above long-term resistance at $50 and is now trading at multi-year highs. The break of the long-term trading range could easily see $70 by the end of the year.

• Then: $47.19
• Now: $58.41
• Return: 24%
• Total return: 28%

NUTRIEN (NTR.TO)

While shipments of fertilizers were incredibly weak in 2017, they’ve been showing signs of rebounding into 2018. Between Oct. 3 and Jan. 16, shares of Agrium (which was listed on the TSX) gained an average of 13.29 per cent, with 17 of the past 20 periods showing positive results. The period leads the time of year when farmers place their orders for the agricultural input for the spring planting season. Shares of Nutrien topped out shortly after the merger of Agrium and Potash at the beginning of the year, in part due to concerns cited with respect to slowing growth in demand for potash in China and India. On a longer-term scale, a trend of higher highs and higher lows remains intact, suggesting a break of the early year high is a probable outcome.

• Agrium and Potash officially merged Jan. 2, 2018: $69.00
• Now: $66.31
• Return: -4%
• Total return: -3%

BMO EQUAL WEIGHT U.S. BANKS HEDGED TO CAD INDEX ETF (ZUB.TO)

Referring to the KBW Index, a capital-weighted index composed of approximately 24 companies representing leading national money centres and regional banks or thrifts in the U.S., the optimal time to buy the banks on an absolute basis is just ahead of the fourth quarter. Between Sept. 29 and Dec. 26, the bank benchmark has averaged a return of 5.63 per cent over the past 22 years. This seasonal timeframe has shown positive results in 19 of those periods. The BMO ETF tracks a basket of 18 stocks in the U.S. banking industry, each representing an allocation of just over 5 per cent. Reacting to higher yields amongst U.S. treasury bonds, the financial sector in the U.S. has been holding support at its rising 200-day moving average and is poised to move higher once the recent consolidation phase is complete.

• Then: $27.41
• Now: $30.98
• Return: 13%
• Total return: 14%

Total return average: 13%

WEBSITE: http://www.castlemoore.com/