BofA Securities U.S. quantitative strategist Savita Subramanian has provided an in-depth look at which market sectors are attractively valued, a helpful guide for investors aiming to dodge potential potholes in their portfolios.
The timing of this week’s report is excellent given that one of the market’s biggest supports - historically low interest rates - has now been pulled away.
Interest rates and bond yields had been extremely low since the financial crisis, helping to drive investors towards equities. Ms. Subramanian called the higher-than-average ratio of the S&P 500 dividend yield to the 10-year U.S. Treasury yield, “the most bullish metric of the past decade.”
But the ratio, which reached a height of 3.7 in March of 2020, has now returned to below the historic average near 0.6 and will no longer be a factor driving stock prices higher.
While stocks are cheaper than they were a year ago, they are still not cheap relative to longer-term history, the strategist notes. The current forward price to earnings (PE) ratio just below 16 times is in line with the historical average. The PE will climb significantly, however, if Ms. Subramanian’s forecast of a 20 per cent drop in earnings in the coming year becomes reality.
There is a huge variance between sectors that are priced for an economic slowdown and those that aren’t, and also some surprises. “Interestingly, the biggest laggards year-to-date, Tech and Consumer Discretionary, have not priced in recession risk,” based on their stock prices relative to expected earnings, writes the strategist.
Despite the more than 20 per cent decline in the S&P 500 Information Technology Index, the sector has further to fall as the global economy slows. This should delay investors from buying the dip in technology stocks.
Energy is the top-ranked sector at BofA for the 13th straight month. In terms of the sector’s forward PE ratio relative to the S&P 500, Ms. Subramanian sees the potential for energy stock prices to double.
Materials and financial stocks also screened well. Domestic investors need to be cautious about applying the findings in U.S. materials stocks to the S&P/TSX Composite Materials index, however. The U.S. subindex is largely cyclical stocks like Linde PLC, Sherwin-Williams Co. and Air Products and Chemicals while the domestic index is dominated by non-cyclical precious metals companies.
Within financials, it is the bank subsector that has the most upside, according to BofA’s analysis. The price- to-book value relative to the S&P 500 implies almost 80 per cent price upside. This is encouraging news for Canadian investors looking to build bigger positions in domestic bank stocks, as cross-border valuations tend to follow each other closely.
-- Scott Barlow, Globe and Mail market strategist
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The Rundown
Why GIC rates didn’t pop after the big jump in the BoC’s overnight rate, and why returns could actually fall
A trend to keep your eye on if you’re a GIC rate watcher: concern about rising rates causing a recession has pushed bond yields down from a mid-June peak for the year of 3.5 per cent - and they’ve declined considerably this past week. Competition between alternative banks and credit unions remains aggressive, but what’s happening in the bond market suggests GIC rates may have peaked for the near term. Rob Carrick tells us more.
Also see: U.S., Canadian benchmark bond yields hit 8-week low as weak economic reports reset Fed view
Interest rates have jumped, but old rules of monetary policy suggest they still have much further to go
Central bankers have shocked stock markets and homebuyers with big interest rate increases over the past few months, but policy-makers are still far behind where they should be in the battle to control inflation, according to some simple rules of monetary policy. Ian McGugan explains.
The commodity supercycle is already crashing, blunting Canada’s growth and bruising the TSX
A sharp reversal in commodity prices – hitting everything from copper, to crude oil, to wheat – is sapping investor enthusiasm for the resource sector and dismantling predictions of a supercycle that would immediately reshape the global economy. As in many speculative booms, rising interest rates are largely to blame for the pullback. But investors are equally culpable, after they fell for age-old commodity price hype – no matter how many times they’ve already been burned. Tim Kiladze and Niall McGee report.
Strong dollar looms over U.S. earnings season
Companies reporting earnings in coming weeks are likely to mention one common factor gouging their results: the strong U.S. dollar. David Randall of Reuters reports.
Also see: U.S. dollar cresting as central banks ape Fed
When it comes to investing, time trumps rate of return
Investment manager Biff Matthews reminds us that your rate of return over a short period of time has little effect on the ultimate amount of your wealth. It is only your average long-term rate of return that matters.
Others (for subscribers)
The highest-yielding stocks on the TSX, plus risk data
Number Cruncher: Six TSX dividend stocks that benefit from the soaring U.S. dollar
Number Cruncher: 15 TSX-listed ETFs hold wide moat stocks and have outperformed peers
Friday’s analyst upgrades and downgrades
Thursday’s analyst upgrades and downgrades
Globe Advisor
What a record year for ETF delistings could mean to advisors and investors
Why it’s a good time to buy high-quality companies
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Ask Globe Investor
Question: In 2018, I bought 100 units of Brookfield Infrastructure Partners LP (BIP.UN) at $51.38 on the Canadian side of my tax-free savings account. Because the dividends were declared in U.S. dollars, I later transferred my units to the U.S. side of my TFSA to avoid currency conversion costs. Recently, when I looked at my statement I noticed some changes: Those 100 shares have become 184 (I’m enrolled in the dividend reinvestment plan), the ticker symbol is now just BIP, and the current market price was listed at US$38.21. Can you explain?
Answer: There are two reasons the number of units in your account has grown. First, because you are enrolled in a dividend reinvestment plan, each time Brookfield Infrastructure has paid a distribution you have acquired additional units. Second, Brookfield Infrastructure completed a three-for-two unit split in June, meaning that for every two units you held prior to the split you received an additional unit. If you held 120 units before the split, for example, you would now have 180 units (120 multiplied by 3/2) after the split.
This also helps to explain why the unit price is lower now that when you made your original investment. It’s important to understand that, when a company splits its shares – whether two-for-one, three-for-two or some other ratio – no additional value is created. The market price of the shares simply adjusts to reflect the fact that investors now have more shares. In the case of Brookfield Infrastructure, because the number of shares was multiplied by 3/2, the price post-split would be about two-thirds of the old price. (If you have 3/2 as many shares at two-thirds the price, these numbers essentially cancel each other out and the total value of your holdings stays the same.)
But there’s another reason the current price appears to be lower than your purchase price: The two prices are in different currencies. You bought your shares in Canadian dollars, but they are now priced in U.S. dollars on the U.S. side of your account, so it’s an apples-to-oranges comparison. With the loonie now at about 77 US cents, a stock that is trading at, say, $100 in Canadian dollars is worth about US$77.
Regarding your question about Brookfield Infrastructure Partners’s ticker symbols, the units that trade on the Toronto Stock Exchange under the symbol BIP.UN are identical to the units that trade on the New York Stock Exchange under BIP. The only difference is that BIP.UN is priced in Canadian dollars, and BIP is priced in U.S. dollars. When you moved your units to the U.S. side of your account, only the symbol and currency changed, not the units themselves.
Similarly, Brookfield Infrastructure Corp.’s common shares (which, unlike the partnership units, are eligible for the Canadian dividend tax credit) also trade on the TSX and NYSE. But in this case, the ticker symbol is the same – BIPC – on both exchanges.
--John Heinzl
What’s up in the days ahead
With China’s economy barely growing and a war in Europe and leftist governments now dominating South America, does it really make sense for investors to venture that far away from Canada and the US? Ian McGugan will share his thoughts. And David Berman will look at the latest investment case for buying shares in Loblaw.
It’s a Fed hot summer and other world market themes for the week ahead
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff