This time we’ll look at three stretched asset market trends that should reverse - including signs that investors are becoming more risk tolerant than what is good for them - some surprisingly strong and weak stock performers on both sides of the border, and a podcast where funny people become funnier.
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Valuations
Three stretched trends
There are three market trends that are almost certain to mean revert even if the timing is uncertain. The first trend reversal will make a lot of readers happy, the other two will not.
We’ll start with the domestic real estate market where affordability is wretched for new buyers. The most recent data from RBC Capital Markets shows that 67.2 per cent of pre-tax household income is required to pay the mortgage, utilities and property tax costs of the average Canadian two-storey home. This is not far off the all-time high of 70.2 per cent set at the end of 2023.
The average from 1985 when the data begin and the end of 2006 - I’m using that time period because it pre-dates the post-financial crisis zero rate era – is 44.3 per cent. The average since that point is 52.5.
The housing shortage and accelerated immigration means that pre-crisis affordability levels are unlikely. Levels near 70 per cent are unsustainable, however, and a reversion to at least the mid-50s seems inevitable. Any combination of lower mortgage costs and higher incomes would help improve affordability.
The second trend I strongly believe will reverse towards reality is featured in RB Advisors’ highly readable Charts for the Beach.
Under the heading “individual investors are massive risk takers,” the report notes that BofA Securities client allocations to equities climbed from 39 per cent when the rally began in 2009 to the current 63 per cent. The average beta went from a conservative 0.75 to an extremely market-sensitive 1.25.
The average allocation since 2005 is 56 per cent. The average beta was not mentioned, which is annoying, but should be somewhere near 1.0. The Federal Reserve pushed rates close to zero post-crisis in part to incentivize investment in riskier assets. Equity allocations will normalize, to the markets’ detriment, to the degree bond yields stay near current levels.
The beta should also drift lower, likely after some of the investors who dragged the average so high get their portfolios murdered.
The third mean reversion I expect is the valuation disparity between the conventional market cap-weighted S&P 500 – where performance is currently dominated by the Magnificent Seven stocks – and the equal weighted S&P 500 index where every stock valuation counts the same regardless of size.
BofA Securities U.S. equity and quant strategist Savita Subramanian notes that the equal weight index is trading at an extreme discount to the S&P 500 - “approaching [1990s] Tech Bubble levels” according to the strategist. Based on earnings yields, Ms. Subramanian estimates that the equal weight benchmark should be trading at 12 per cent premium to the cap-weighted S&P 500.
Closing this valuation gap involves underperformance of the Magnificent Seven stocks and a broadening of market leadership by definition, and will have a significant negative effects on the conventional S&P 500 returns.
Tijana Martin/The Canadian Press
Market returns
Some surprising top performers
I pulled the one-month, three-month and year-to-date returns for all stocks in both the S&P/TSX Composite and the S&P 500, a simple exercise that nonetheless provided some surprises. Year to date the top ten domestic performers were dominated by gold miners, including Iamgold Corp., Osisko Mining Inc., Wesdome Gold Mines Ltd. and New Gold Inc. Oil and gas services company CES Energy Solutions is the top performer so far in 2024.
Sleep Country Canada Holdings - thanks to a Fairfax Financial takeout offer - is performing, in the top ten for both one and three months, as is Shopify Inc. and Algoma Steel Group Inc.
More negatively, Cameco Corp., Denison Mines Corp. and Energy Fuels Inc are among the recent laggards despite hopes for nuclear power expansion. Copper producers Lundin Mining Corp. and Hudbay Minerals have also taken a hit recently.
In the U.S., Super Micro Computers Inc. is up 120 per cent year to date, second only to Nvidia’s 148 per cent, despite falling 30.2 per cent in the past month. The volatility in the tech sector has been ridiculous this year, both ways. Howmet Aerospace Inc., a company that makes equipment for commercial airplanes, is among the top performers this year, up almost 80 per cent. General Electric has exhumed itself to the tune of 67.5 per cent year to date.
On the downside, Intel Corp. has endured a relentlessly bad year – it’s in bottom ten performers for all time periods. Lululemon Athletica Inc. got no boost from the Olympics, down 50 per cent
Diversions
A podcast where funny people get funnier
Conan O’Brien Needs a Friend is one of my favourite podcasts because one of his best skills is making funny people even funnier. When the guest is someone like Bill Hader, it can make you bust out laughing in public.
The August 12th episode featured former Beastie Boys Michael Diamond and Adam Horovitz. They told a great story about breaking into a display case to play one of their gold records, which turned out to be piano covers of Barry Manilow songs.
The essentials
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The Rundown
After Starbucks Corp. announced a new chief executive officer last Tuesday, its share price jumped 24.5 per cent. Now comes the hard part: turning around the global coffee retailer after weak sales raised questions about whether the stock’s go-go days are over. David Berman has some advice for investors thinking of betting on a quick turnaround.
The pace of change in the economy and markets these days adds some urgency to a question of how often advisers and clients should meet - and what needs to be discussed. Rob Carrick has some recommendations.
Report on Business journalists go inside the cultural shift that seeded a money laundering crisis, succession woes and a leadership exodus at TD Bank.
What’s up next
Domestic CPI will be released Tuesday before market open with a 2.4 per cent year over year inflation rate expected. Retail sales, my pick for the most important monthly data point, is out on Friday. Retail sales provides a window into the domestic consumer’s battle against higher rates.
For equities, the big news will be the beginning of bank earnings season on Thursday when TD reports. BNS and BMO will follow on the 27th.
The Americans don’t have much in the way of economic data to worry about coming up – durable goods orders are about it on the 26th. Equity-wise I’ll be watching Palo Alto Networks Inc., one of the most dominant network securities stocks, when they report Monday after the close. Citi global strategist Chris Montagu named cybersecurity as the world’s best performing investment theme.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)