Finding Value

On Friday, the U.S. Bureau of Economic Analysis announced that in the second quarter of 2019, GDP grew at 2.1% (a bit higher than the expected 1.8%). Government spending (U.S. deficit is now at about 3/4 of a $ trillion, on track for over a $ trillion through fiscal 2019) rose at a 5% annualized pace. The consumer was also a factor, with a 4.3% annualized growth rate (after a couple of light quarters in Q4 2018 and Q1 2019). Interestingly, the consumer was borrowing and drawing down savings (following the example set by the government), because incomes only grew at a 2.5% rate.

The rest of the economy (business capex spending, non-residential investing, housing, inventory accumulation and net-exports) declined at a rate of -12.1%. Our friend, economist  David Rosenberg called this report "lopsided", commenting that you would have to go back 13 years to see something similar :"This report, contrary to conventional wisdom, was the furthest thing from being universally robust".

With 10 year U.S. treasury notes yielding just above 2%, bond markets might agree.

And heading into this weeks U.S. Federal Reserve (FOMC) interest rate announcement, probabilities of a 1/4% cut are 75% and 25% for a 1/2% cut. So, the Fed is obviously worried about the economy. (source: CME Group):

Meanwhile in stock markets:

With 44% of S&P 500 companies reporting Q2 earnings, the estimated and actual blended results are showing another negative quarter (-2.6%).

But stocks are making new highs again, leaving Price to Earnings (P/E) valuations (what we might call the fundamental importance of stock ownership) stretched at 17.1 times (and well above the 10 year average of 14.8 times):

The dividend yield on the S&P 500 is currently at 1.86%.

10 year US. treasury note yield is 2.05%.

10 year Canadian government bond yield is 1.46%.

Cash equivalent (HISA) is approx. 1.9%.

The Canadian high yield fund that High Rock manages for Scotia Bank (AHY.un) has paid distributions of $.44 (trailing 12 months, F class) and with the NAV at 7.75, that comes to an annualized yield of approximately 5.6%. Our clients have access to a similar HY strategy in their portfolios (without the MER, that brings it close to a 7.75% yield). This is not at all  intended to be a solicitation, merely an example. Investors should consult with their advisors to ensure that this is an appropriate investment for your portfolio.

If the economy is slowing (which appears to be the case), how do you want to be positioned?

Do you want to be vulnerable to risk assets (stocks) that could conceivably drop 12% (about 1 standard deviation from the mean) or more? That makes the dividend somewhat less than relevant, should that situation materialize.

Or, might you wish to be less vulnerable (less than fully invested in equity markets) and have a portion paying you to wait it out and perhaps take advantage of the 12% move lower in equity markets (if/when that should occur)?

Passive strategy proponents will tell you to stay fully invested. Managed strategy proponents will tell you to be less invested.

There is room for both. Patient, value-oriented investors will inevitably out-last momentum traders. Time is on your side.