Full episode: Market Call Tonight for Thursday, December 6, 2018
Stan Wong, director and portfolio manager at Scotia Wealth Management
Focus: North American large caps and ETFs
Volatility remains elevated in equity markets as investors contend with anxieties about China-U.S. trade frictions, the pace of interest rate hikes by the U.S. Federal Reserve Bank and the prospects of a U.S. economic slowdown. Since the beginning of October, the CBOE Volatility Index (VIX) has averaged near a 20 per cent level, significantly higher than its five-year average of just under 15 per cent.
This week, an inversion at the short end (two- and five-year and three- and five-year) of the U.S. Treasury yield curves heightened recession fears and weighed heavily on stocks. An inverted yield curve, where short-term rates are higher than long-term rates, has historically been a precursor to an economic recession. We note however that these short-end measures of yield curve steepness have not been reliable precursors to recessions. As a recession indicator, the more reliable yield curve spreads have tended to be those with larger maturity gaps such as the two- and 10-year, which still currently indicates a normal yield curve. Even so history tells us that the onset of an inverted yield curve is not necessarily a harbinger of falling equity prices. Such inversions have occurred seven times since the early 1950s and all but one preceded price advances for the S&P 500 Index. The S&P 500 Index rose a median 19 months before peaking after an inversion, with returns reaching 21 per cent.
Below are some of our general market observations and viewpoints:
- Strong corporate earnings. Over 82 per cent of S&P 500 companies reported positive earnings surprises for the Q3 earnings season. The 28 per cent year-over-year earnings growth for the index is one of the strongest in a long time.
- Discounted valuations. With the recent selloff combined with stronger earnings, the S&P 500 Index currently trades at 15 times forecast earnings and the index’s multiple has contracted 18 per cent from a year ago.
- Solid economic data. U.S. economic data largely remains healthy. The Conference Board’s Leading Economic Index (LEI) continues to trend higher with no real signal of an economic slowdown in the near-term.
- Technical view. When reviewing the S&P 500 Index charts, we see a possible triple bottom forming, a potential bullish reversal pattern.
- U.S. Presidential cycle. Since 1928, the third year of the U.S. presidential cycle has historically been the strongest for the S&P 500 Index, averaging almost a 13 per cent return.
- The December effect. Since 1950, no other month has a higher average return for the S&P 500 Index or has been higher more often than the month of December.
- Fearful market. The CNN Fear & Greed Index is currently indicating a prevailing investor sentiment of “extreme fear” in the market. We last saw these levels of extreme fear during the February-March lows earlier this year. As Warren Buffett once advised: “be fearful when others are greedy and greedy when others are fearful.”
Overall we remain constructive on the equity markets. We believe that in order for the current turbulence to evolve into a protracted bear market, we would need to see signs of a profit recession, significant tightening of liquidity and/or more conclusive data points signaling an economic slowdown. We don’t see any of these indicators today. Indeed, corporate earnings are expected to grow nine to 10 per cent in 2019. The Federal Reserve seems to be dialing back its hawkish tone and China-U.S. trade tensions appear to be easing.
In Stan Wong Managed Portfolios, we continue to be positioned with a relatively high weighting in U.S. equities (and the U.S. dollar) compared to Canadian equities. We have no exposure to European stocks and limited holdings in the Asia-Pacific and emerging market areas (although we note some attractive valuation discounts in emerging markets). Financials, consumer discretionary, communication services and healthcare represent our largest sector weightings but we anticipate a larger shift to defensive sectors (consumer staples, healthcare and utilities) as the economic and market cycle matures. We expect high quality attributes (high return on equity, low financial leverage, stable earnings growth) to become more important as the global macroeconomic backdrop becomes less certain. We anticipate volatility levels ahead to be more pronounced and uneven moving forward. Investor sentiment will continue to ebb and flow with equities ultimately grinding higher. As always we will emphasize active stock selectivity and the use of stop-loss and other risk-management strategies.
MasterCard is poised to benefit from powerful global secular trends over the next decade as international economies grow and the use of digital currency and electronic payments expands. Continued growth in e-commerce and consumer online shopping (record Black Friday and Cyber Monday sales last month for example) will further boost MasterCard’s revenues and earnings. Today the company boasts over 800 million MasterCard branded credit and other payment cards in more than 200 countries. This week the company authorized an additional US$6.5 billion share buyback program and boosted its quarterly dividend by 32 per cent, which is reflective of management’s commitment to enhancing shareholder value. MasterCard has reported thirteen consecutive quarterly positive earnings surprises. The shares currently trade at a forward price-earnings multiple of 27 times with a forecasted long-term earnings per share growth rate of around 20 per cent. Given the recent market weakness, MasterCard shares provide a buying opportunity in a high-quality asset with reliable earnings growth. The company reports its next quarterly results on Jan. 31.
Pfizer is one of the world's largest research-based pharmaceutical firms, with annual sales over US$52 billion. The company spends nearly US$8 billion a year on research and development keeping its pipeline robust with new products. Indeed, Pfizer today has nine blockbuster drugs bringing in over US$1 billion in annual revenues. The company’s top prescription products include: cholesterol-lowering drug Lipitor, pain management drugs Celebrex and Lyrica, pneumonia vaccine Prevnar, erectile dysfunction treatment Viagra, arthritis drug Enbrel, antibiotic Zyvox and high-blood-pressure therapy Norvasc. Pfizer’s consumer health products include leading brands such as Advil, Centrum and Robitussin. As a leading global healthcare company with rising return on equity (ROE) metrics, Pfizer shares provide investors with both defensive and growth characteristics. Pfizer shares currently trade at 14 times forecast earnings with a long-term estimated earnings per share growth rate of 7 per cent. The shares yield a 3.1 per cent dividend which is forecasted to grow modestly over the next several years.
The Consumer Staples Select SPDR ETF provides investors with exposure to a basket of U.S. large cap consumer staples stocks including companies from cosmetic and personal care, household product, pharmaceuticals, food and beverage and tobacco industries. Given that most investors today are likely overweight the more popular FAANG stocks and underweight defensive stocks such as consumer staples, it makes sense to revisit portfolio sector weightings as the economy matures. During the late-cycle and slowdown phases of an economic period, it is typical to see defensive sectors (consumer staples, healthcare and utilities) outperform the broader equity market. Indeed, defensive stocks generally have more stable and predictable earnings profiles, but during an economic slowdown people still need toothpaste, toilet paper and groceries. The Consumer Staples Select SPDR ETF currently yields a 2.7 per cent dividend and includes companies such as Procter & Gamble, Coca-Cola, Walmart and Costco Wholesale.
PAST PICKS: DEC. 7, 2017
- Then: $180.14
- Now: $139.53
- Return: -23%
- Total return: -23%
ING GROEP (ING.N)
- Then: $18.13
- Now: $11.59
- Return: -36%
- Total return: -33%
VANGUARD FTSE EMERGING MARKETS ETF (VWO)
- Then: $43.64
- Now: $39.41
- Return: -10%
- Total return: -8%
Total return average: -21%