By Adam Mayers, Contributing Editor
A perfect storm of bad news for stocks and bonds in the first half of the year shaved 21% off global stock indexes, reflecting economies and markets undergoing a massive transition.
The interest rate equation has changed from a decades long decline to rapid, upward spikes to contain inflation, which is at 40-year highs. Overlaid on that is pandemic-induced supply shortages.
Tom Bradley, chair of Vancouver-based Steadyhand Investments, summed up the first half in a letter to clients as “the worst 6-month period in history for balanced portfolios.”
So now what?
A few threads have emerged in recent conversations with market strategists, fixed income experts, and portfolio managers. There is an abundance of caution about the outlook with a consensus that there is a high probability of another leg down for stocks this fall. That may be followed by a recession, and there is no consensus whether that event would be short and shallow or something longer and deeper.
RBC’s economists predict a moderate recession in 2023. Globe and Mail economics writer Ian McGugan cautioned recently that investors should be wary of friendly recessions. They don’t happen very often.
Even so, share prices are becoming attractive for top quality companies and beaten down tech leaders. Prices may not have bottomed, the experts say, but for patient investors comfortable with volatility and with a longer-term view, the opportunity is there. On the fixed income side, there is a hunch that large interest rate increases may be over, which makes current yields attractive.
And finally, investors are feeling lousy and are reminded daily of rising prices when they buy groceries or gas. Until they feel better, the upside is limited. But low expectations are a fertile ground, as Mr. Bradley noted. “I don’t know when markets will bottom but know that I want to own a diverse collection of leading businesses when it does,” he wrote.
Bonds at a bottom?
Bonds had their worst start to a year in half a century. The last time they performed this poorly was during the oil-price shock of the 1970s. The reason has been three interest rates increases since March to tame inflation. This includes last week’s 100 basis point increase by the Bank of Canada, its biggest single increase since 1998. The bank’s key rate is at 2.5% and sets all other rates, including car loans and lines of credit. For example, RBC’s home secured line of credit was carrying a hefty 5.2% rate at the time of writing.
Konstantin Boehmer, a portfolio manager at Mackenzie Investments in Toronto, co-heads the company’s fixed income team. He is among those who think most of the rate increases are behind us. He feels rates may rise a bit more, but not much. That makes bonds more attractive than they’ve been in a long time.
“I don’t have a crystal ball but what we’ve seen is extraordinary in terms of the magnitude of increases,” he says. “We’ve seen 50 basis point hikes, we’ve seen 75 basis points hikes. There could be a little bit more to go yes, for sure. But a lot of the heavy lifting has already happened and that gives me confidence.”
He oversees the Mackenzie Core Plus Canadian Fixed Income ETF (TSX: MKB). The ETF has declined 12.2% year-to-date (as of July 20), with a one-year drop of 11.5%. The fund has a trailing 12-month yield of 2.46% and holds mainly Canadian provincial and federal bonds, along with high quality corporate debt.
Mr. Boehmer sees a reasonable probability of recession by the end of the year. Historically, that is good for bonds as rates will start to fall thereafter. That would make current bond yields attractive. For example, a five-year bond yielding 5% today becomes worth more if new bond yields fall to 4%. That drop of one percentage point means that over five years the return becomes 5%, plus 500 basis points, or another 5%.
Tech stock opportunity
The tech stock sell-off is entering its second year and some of the biggest pandemic stars are this year’s goats. The downdraft has captured such semiconductor leaders as Netherlands-based ASML Holding NV (NDQ: ASML). ASML produces the equipment necessary to manufacture microchips. ASML has full order books and a virtual monopoly on the machines that make the chips yet is down 38% year-to-date. Another victim is Nvidia Inc. (NDQ: NVDA), best known for the graphic processor units used in gaming systems and high-end workstations. It is off 42% this year. Blue chips have also suffered. Microsoft (NDQ: MSFT) is off 23%, Alphabet (NDQ: GOOG) is down 22%, and Facebook, renamed Meta Platforms (NDQ: META), is off 47%.
Hans Albrecht, vice-president, portfolio manager and options strategist at Horizons ETFs in Toronto, says the sell-off is part of a broader market repricing. Just as share prices overshoot in a rising market, they overshoot in a falling one.
Mr. Albrecht says there is plenty of value and potential in the tech sector. Nvidia, for example, rose more than 500% from its March 2020 low to its August 2021 high. The current sell-off seems steep, but the shares are still up 95% from the low.
Greg Taylor, chief investment officer at Purpose Investments Inc. in Toronto, also noted recently that stocks playing to work from home themes have seen exaggerated sell-offs.
Zoom Video Communications Inc. (NDQ: ZM), which has become a household name, is off 70% in the last 12 months. Teladoc Health Inc., (NDQ: TDOC), a leader in telehealth services, is down 72% from its high. The best of them will continue to thrive, he says.
“I certainly don’t see Zoom going away anytime soon or DocuSign or Pelaton,” he said. “It’s just how do you value them?”
Be guided by company fundamentals
Matt Bryson, senior vice president of research with Wedbush Securities Inc. in Boston, says it is impossible to time the market, so keep an eye on the future and where a company’s prospects lie, rather than on where it is now.
“The market may continue to deteriorate,” Mr. Bryson said. “But if you like what a company is doing and you think it’s going to outperform its peers, invest in it.”
Adam Mayers is a contributor to The Globe & Mail’s Report on Business and a former investing columnist at The Toronto Star. His website is adammayers.com. He lives in the greater Toronto area.