Stan Wong, Portfolio Manager at Scotia Wealth Management
Focus: Large Stocks and ETFs in North America
With US inflation hitting a 40-year high of 8.6 percent in the twelve months through May, stock market volatility continues to rise significantly. The S&P 500 Index, the Nasdaq Composite Index and the MSCI Global Index all slipped into a technical bear market. Year-to-date, the energy sector was the only positively performing sector to advance more than 25 percent in most major markets. To curb inflation, the Federal Reserve last week raised the benchmark interest rate by 75 basis points – the most aggressive rate hike in nearly 27 years. Undoubtedly, the combination of high inflation and hawkish central banks around the world has forced many market participants to consider the possibility of a looming recession.
Looking at the recent price action and various sentiment indicators, it appears that the market has set a price in a recession. From a fundamental perspective, valuations are down significantly with the S&P 500 now trading at 16 times price-to-earnings forward. From a technical point of view, stocks are oversold with most of the major markets trading up to key RSI levels. Market breadth in general is particularly weak with only 5 percent of the S&P 500 components trading above their 50-day moving average and only 15 percent above their 200-day moving average. Often considered a measure of fear in the market, the CBOE Volatility Index (VIX) has risen to critical levels. Additionally, the bearish sentiment reading released by the American Association of Retail Investors (AAII) recently reached a 10-year high, surpassing March 2020 levels.
Despite the gloomy mood in the markets and a challenging economic climate, we see the opportunity as investor sentiments turn to fear and panic. As always, we encourage investors to heed the old investment saying “Be afraid when others are greedy and be greedy when others are afraid.” Undoubtedly, the greatest opportunities are found in the most uncomfortable and troubling times. To be clear, we view bear markets as periods of tremendous opportunity for cautious investors looking beyond uncertainty in the near-term time horizon. The eventual easing of supply chain stresses and cooler inflation data should act as a catalyst for a meaningful stock market recovery. We have already seen core CPI inflation (CPI excluding food and energy) heading lower during previous readings. In addition, it appears that the upcoming US midterm elections will lead to a more business-friendly Congress.
In Stan Wong’s Managed Portfolios, we have tilted our equity value allocation and reduced our weight in growth stocks. The sectors of finance, energy, materials and healthcare are particularly attractive to us. We remain cautious about the technology sector (and other multiple higher growth areas) given the high interest rate environment and relative valuations. The S&P 500 IT index recently traded at its highest valuation at 7.8 times price-to-sales in December (now at 5.3 times price-to-sales). In March 2000, the technology index reached its multiple price-to-sales highs 7.5 times before declining 82 percent over the next 30 months. From a geographic perspective, we like US stock markets for the breadth and depth of their high-quality names while Canada looks attractive given its relative valuation discount. In our fixed income allocation, we undervalue government bonds in favor of inflation-protected bonds and short-term corporate bonds.
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Costco Wholesale (COST NASD)
Last bought this month for around $450
With more than 116 million members worldwide and over $225 billion in projected revenue for 2022, Costco is a dominant name in the group merchandising space. Costco continues to enjoy an impressive level of loyalty in the United States and Canada with membership renewal rates fixed at around 92 percent. Among large-scale retailers, Costco is clearly a leader in raising cost, purchasing power, and store efficiency – allowing store traffic to remain exceptionally high. Despite the large size of its warehouses, the company focuses its purchasing power on a relatively small number of items (about 4,000 units in the store compared to 140,000 units at Walmart’s majors). Amid rising fuel costs and inflationary pressures, Costco’s value proposition continues to grow more attractive to its members. The company announces its next quarterly results on September 22, 2022.
ISHARES S & P / TSX COMPOSITE HIGH DIVIDEND INDEX ETF (XEI TSX)
Last bought this month ~ $25
The iShares S&P/TSX Composite High Dividend Index ETF is designed to replicate the performance of the S&P/TSX stock income index. The XEI ETF provides a compelling opportunity for investors seeking a solid dividend income from well-established, large-cap Canadian companies. XEI currently pays a dividend yield of 3.9 percent with the largest holdings in Canadian banks, pipelines, utilities and telecommunications. With the iShares S&P/TSX Composite High Dividend Index ETF continuing to drop more than 12 percent over the past two months, this presents an attractive buying opportunity for high-quality Canadian dividend payers. The ETF carries a 22bps fee.
Shell PLC (SHEL NYSE)
Last bought this month ~ $50
Shell PLC is one of the world’s largest integrated oil and gas companies with some of the most attractive assets in the global energy sector – notably the world’s largest LNG company and largest chain of gas stations. Shell’s massive global reach extends across more than 70 countries. Last month, the company reported its highest quarterly profit ($9.1 billion) since 2008 and announced plans to increase its dividend. Shell can purposefully increase its dividend in the coming quarters given its conservative 20 percent dividend payout ratio. Shell is also currently running a share buyback program worth $8.5 billion this year. As one of the world’s major LNG players, Shell will benefit from rising global gas demand and rising prices over the next decade. The shares are earning 3.9 percent and trading at just 5.3 times expected earnings. The company announces its next quarterly results on July 28, 2022.
Previous Picks: Jun 24, 2021
Conocophiles (COP NYSE)
- Then: $61.39
- Now: $92.92
- Yield: 51%
- Total Return: 55%
United Public Health Group (NYSE)
- Then: $398.87
- Now: $499.88
- Yield: 25%
- Total Return: 27%
iShares Global Fund (IXG NYSE)
- Then: $77.90
- Now: $65.49
- Yield: -16%
- Total return: -13%
Average total return: 23%
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