I wrote about the rising risks to dividend and income investors from rising bond yields on Oct. 4 and a very nice e-mail from a reader suggested I write about portfolio strategies to deal with them. I wish I had the answers, but unfortunately too much has changed in the global economy since the last prolonged period of U.S. inflation and there are multiple market scenarios that are still in play. Here are four.
1. In the past, buying energy and commodity stocks was the best way to generate outperformance in periods of inflation. The problem now, however, is that inflation pressure is centred in the United States and commodity demand growth is now almost entirely an emerging markets phenomenon.
The rise in Treasury yields has resulted in a strong U.S. dollar relative to developing world currencies and, because commodities are priced in greenbacks, this has made resources much more expensive in emerging markets. It’s possible that resource demand falls as a result of this cost pressure, and the upside to resource prices is limited.
2. The developed world demographic situation is also much changed from the 1970s, when inflation was last a major driver of asset prices.
There is a plausible scenario where an aging income-hungry investor population moves portfolio funds from equities, where rising wage costs are hurting profit margins and stock prices, and into fixed-income markets where yields are climbing. In this environment, the bond buying would push yields back down, potentially to the point where dividend and income stocks start outperforming most other equity market sectors again.
3. There is also the possibility that equity markets start to look like 1998 and 1999, with narrow leadership that drives equity indexes sharply higher.
In this case, wage and input-cost inflation compresses profit margins for the majority of companies. Market sectors such as biotechnology and information technology, which have tiny wage costs as a percentage of revenue, can preserve their earnings growth and attract steadily more investor funds. Eventually, their popularity makes these stocks obscenely expensive, but a ton of investor profit can be generated with them before the bubble pops.
4. Another scenario is that we are entering a market environment where value stocks will finally outperform, as highlighted by Morgan Stanley U.S. equity strategist Michael Wilson in an Oct. 7 report.
“Bonds and bond proxies are sensitive to moves higher in interest rates from any level, while growth stocks remain immune until rates cross a certain threshold,” he said. "Was that level breached last week? We think the answer is yes, because growth stocks now are less attractive while many discarded value stocks, like financials, become more appealing.”
None of these scenarios seems more likely to me than any other at the moment, which is an inconvenient position to be in. It’s better though, I think, to wait for a while and see how things unfold rather than to commit to a single forecast just to have an opinion. One thing that’s certain is that investors are in for an interesting ride.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
General Electric Co. (GE-N). There’s an old saying in investing: Don’t try to catch a falling knife. As if General Electric Co. investors need to be reminded. During the longest bull market in U.S. history – a nearly decade-long run that has seen the S&P 500 more than quadruple from its 2009 lows – GE has been a spectacular bust. Its shares now fetch less than one-third of their prefinancial crisis value, a crushing comedown for the industrial giant that was once the world’s largest company and whose stock was widely viewed as a safe, blue-chip investment. John Heinzl explains what’s happened with the stock and what the outlook is like now for investors.
The Rundown
No quick fix for Canadian natural gas, but there are signs of hope
When China decides it needs a lot of something, the fortunes of entire industries can change completely. Throughout the 2000s, amid one of the greatest industrial expansions in human history, China’s insatiable appetite for resources of all kinds fuelled the so-called “commodities supercycle,” which in turn sustained a decade of Canadian stock market outperformance. Chinese demand now has the potential to transform another commodity that Canada is increasingly positioned to supply – natural gas. Tim Shufelt explains, and looks at some stocks that could benefit from the trend. (for subscribers).
Thinking of asking a billionaire for investing advice? Think again
Anyone looking for advice or a guidepost on investing would reasonably look to people who have hit on some big-time success. But billionaires aren’t always the best role models for regular people. John Reese explains why (for subscribers).
The investment advice business is testosterone city – here’s how women can fight back
Too few men in the investment advice business know how to talk to female clients. “Women have more and more money, and they’re looking for advisers that they connect with,” said Judy Paradi of the financial services consulting firm StrategyMarketing.ca. “And on the other hand, we talk to advisers all the time who simply do not know how to find female high-net-worth clients. They’re used to prospecting for men, they’re used to the golf course, they’re used to Sales 101.” Ms. Paradi and her business partner, Paulette Filion, offer workshops and online courses that show advisers how to earn the trust of female clients. Ms. Paradi and Ms. Filion can help women as well by showing them what female-friendly financial advice looks like. Rob Carrick takes a look at their advice to female investors and advisers who want to better serve female investors.
Others (for subscribers)
Sell dividend aristocrats, buy value stocks: strategist
Tuesday’s analyst upgrades and downgrades
Tuesday’s Insider Report: CEO purchases $3.6-million in this REIT yielding over 6%
The 40-year-old virgin: When you’ve never experienced a bear market in bonds
The Globe’s stars and dogs for last week
Others (for everyone)
Are transportation stocks the market’s canary in a coal mine?
Ask Globe Investor
Question: If a surviving spouse inherits a deceased spouse’s tax-free savings account (TFSA), does this inherited TFSA continue to grow via dividends and capital gains so long as the inheritor survives?
Answer: If you designate your spouse as the “successor holder,” and assuming your spouse takes over your TFSA, the TFSA continues growing tax-free after your death. Your surviving spouse steps into your shoes and becomes the new TFSA holder.
If your spouse is designated as a “beneficiary” of your TFSA, instead of the successor holder, your spouse has until Dec. 31 of the year following the year of death to contribute any payments received out of your TFSA, up to the date of death value, into his or her own TFSA without affecting your spouse’s unused TFSA contribution room. The disadvantage here is that all income earned on the TFSA assets, as well as any increase in the fair market value of the TFSA’s assets after death, from the date of death until the date the TFSA is paid out to the spouse beneficiary (or Dec. 31 of the year following death, if earlier) will be taxed as ordinary income to the beneficiary. That is why it is usually preferable to designate your spouse as a successor holder on your TFSA.
--John Heinzl
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What’s up in the days ahead
This upcoming U.S. earnings season could be a lot more interesting than you may expect. David Berman will tell us why.
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Compiled by Gillian Livingston