Michael Wilson, a U.S. equity strategist at Morgan Stanley, sees equity returns for the remainder of 2022 as a race against time. In simple terms, the Federal Reserve needs to squash inflation before an economic slowdown forces corporate America to cut profit forecasts en masse.
Mr. Wilson identified three negative trends during the current quarterly earnings reporting season of the S&P 500 that suggest problems ahead for growth and earnings. First, consumers pinched by inflation are moving downscale, avoiding higher-end restaurants in favour of cheaper quick-service restaurants.
Second, the U.S. home renovation trend is slowing, a sign that rising interest rates are threatening a housing industry that accounts for almost 20 per cent of gross domestic product. Stanley Black & Decker Inc. has already cut full-year profit guidance and management at Best Buy Co. Inc. noted a slowdown in consumer electronics.
The third trend is bloated inventories. Walmart Inc. is the most prominent example of consumer companies that ordered inventory in anticipation of an accelerating post-pandemic economy. Instead, a significant portion of these goods have gone unsold as consumer demand weakened.
These signs of slowing growth should be good for bond markets – lower growth expectations lead to lower bond yields, and bond prices climb. Indeed that was the case in July as the iShares Core U.S. Aggregate Bond ETF gained 2.5 per cent.
Equities also rallied in July and Mr. Wilson is concerned this might be premature. The lower bond yields imply that fixed income investors believe the Fed will get inflation under control but “it may come with a heavier cost than normal, potentially a recession while they are still tightening, which may leave a very small window for stocks to work before earnings surprise on the downside,” he wrote.
Morgan Stanley expects that cuts to profit guidance will intensify in September and October this year as third-quarter earnings disappoint (thanks to weakening economic growth) and full year estimates can no longer be supported.
Equity markets are currently balanced between hopes that the peak in inflation pressure is behind us with consumer prices set to drop significantly, and fears that the tightening monetary policy that central banks used to tame inflation will cause a recession.
Tactically, I will be watching leading indicators of recession – like the steepness of the U.S. yield curve – while biding my time until market volatility during the fall months provides equity bargains.
A surge Friday in bond yields and drop in bond prices following much stronger than expected U.S. jobs data show just how treacherous it can be predicting the path forward.
-- Scott Barlow, Globe and Mail market strategist
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The opportunity for investors amid the latest superpower shoving match
The superpower shoving match this week over the future of Taiwan illustrates why even peace-loving investors may want to consider adding defence stocks to their portfolios. The new showdown between the United States and China comes on the heels of the Russian invasion of Ukraine in February. It underlines the world’s worrisome tilt toward armed conflict – or, at least, heated confrontation and snarling displays of military might. As long as that trend continues, Ian McGugan tells us big U.S. defence contractors such as Raytheon Technologies Corp. and Lockheed Martin Corp. offer an attractive counterweight to more volatile sectors of the economy.
How job postings can indicate when a stock is undervalued
There is worrisome news coming out of some highly valued companies such as Apple, Meta Platforms, Tesla and Shopify, to mention a few. They all have recently reported a slowdown in job hirings. This does not bode well for their stock prices, according to new research. As Dr. George Athanassakos tells us, the paper posits that one way to separate highly valued from overvalued companies is to examine the rate of job postings by the companies.
Others (for subscribers)
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Ask Globe Investor
Question: I think that the best time for buying bonds may yet lie in the future. However, I’ve been using short-term alternatives for a while and more recently have invested in iShares 0-5 Year TIPS Bond Index ETF (CAD-Hedged) (XSTH-T). This ETF is focused on short-term U.S. TIPS (Treasury Inflation-Protected Securities). Its distributions year-to-date (which are variable each month) have been $1.24 (about 3.3 per cent for partial year only). The MER is low at 0.16 per cent. Sure, market value has decreased by a fraction this year, but I believe this offers the benefits of inflation protection (through increased/variable distributions) and short duration. Is this a good combination at this time? Nothing much is ever mentioned about this bond alternative. Why not?
Answer: This fund has been in existence for barely a year (it was launched July 6, 2021). However, it has attracted considerable investor interest, with more than $153-million in assets under management.
The face value and coupons on TIPS rise with inflation, so they do provide some short-term protection. Despite that, the fund’s total return for the year (to July 28) is down slightly at minus 0.06 per cent. That’s much better than most other bond ETFs, but it’s still a negative.
The monthly distributions are totally unpredictable and therefore useless in trying to calculate forward yield. The fund paid out 6 cents a unit in March, 20.8 cents in April, 25.2 cents in May, and then a whopping 41 cents in June. In July it slipped all the way back to 15.5 cents. Who knows what August will bring?
This is a short-term bond fund, so the gains or losses will never be dramatic. It’s a better choice right now than BlackRock’s iShares Core Canadian Short Term Bond Index ETF (XSB-T), which shows a year-to-date loss of 3.25 per cent. But you’d have been better off putting the cash in the iShares Premium Money Market ETF (CMR-T). It’s only ahead a paltry 0.33 per cent for the year, but at least it’s on the plus side of the ledger.
What’s up in the days ahead
Ian McGugan will try to make sense of the conflicting and confusing signals in the economy and capital markets right now. Plus, we find out what David Barr of PenderFund Capital Management is up to in his portfolio.
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Compiled by Globe Investor Staff