Timely
portfolio advice
Every year
I try to offer some timely investment advice. While I’m not one to make big,
bold predictions, I (like most) have an opinion as to where good investment
opportunities are to be found. This week, I’ll summarize a detailed memo I sent
to our firm’s financial advisors recently on various investment segments. In
brackets, next to each section title, is my general recommendation to have an
over-, under-, or normal- weight position.
A weak
economy and corporate fraud have contributed to the battered stock market. But
what has gone unnoticed by many investors is that corporate bonds have been
beaten up even more – despite the fact that they’re lower risk than stocks.
Bond market
watchers keenly watch what’s known as the “corporate spread”, which is
calculated as:
Yield on
Corporate Bonds – Yield on Government Bonds.
I studied
fifty years of this data in the U.S.; and the current “spread” is at the
highest point that it’s ever been during those fifty years. In Canada, the
spread is at a ten-year high. Corporate bonds appear to offer better value than
stocks at this point in time; so my recommendation is generally to resist the
urge to go overboard on stocks. Rather, consider reorganizing your bond
exposure to reduce government bond holdings, in favour of corporate issues.
If you want
to invest in this segment via a mutual fund, the following are worth checking
out: Fidelity American High Yield, GGOF
High Yield Bond, Northwest Specialty High Yield (this one’s more aggressive),
PH&N High Yield, Standard Life Corporate High Yield A, Trimark Advantage
Bond, and Trimark Global High Yield.
If the
valuation of U.S. and overseas stocks are compared, you will generally find
that better opportunities exist outside of North America. Current valuation
metrics, such as price-to-earnings (P/E) multiples, show overseas stocks
trading at a 30% discount to North American stocks. Also, comparing each
region’s total stock market value in relation to gross domestic product shows
overseas stocks as the better relative value.
Among
overseas stock funds, my favourites include AGF International Stock, Brandes
International Equity, Mawer World Investment, Templeton International Stock,
and Trimark International Companies. Could the valuation gap persist or even
grow? Sure, but I’m making a longer term bet that the market will eventually
recognize the better opportunities available overseas.
I’ve always
had a bias in favour of equity managers that are highly sensitive to the price
they pay for stocks. While nobody wants to pay too dearly for an investment,
some are stingier than others. With general economic uncertainty, sluggish
profit growth, and persistently high valuations on stock markets, a value style
of selecting stocks simply provides less uncertainty.
While
that’s my opinion, not a fundamental law, it’s also worth mentioning that
nearly 100 years of stock market data backs up my assertion. My recommendation
is to build portfolios around value-conscious stock pickers. Then, peripheral
choices can fill in other specific or aggressive portfolio needs.
I publicly
stated that small caps were overvalued and poised to outperform in February
2000 (in a Globe and Mail article), in October
2001, and in January
2002.
After my
overweight recommendation and a period of strong outperformance by small cap
funds, I’d now recommend taking some profit off the table and giving small cap
funds a more normal weighting.
Hard assets
include real estate, natural resources, and precious metals. While they’ve had
a good run over the past couple of years, a longer-term holding (at a normal
weighting) remains a sound idea. (See the January 2002 article above for fund
recommendations.)
My advice
is not a prediction for 2003, but rather an opinion that today is a good time
to makes some portfolio shifts that I expect to be beneficial over a longer
period of time. My advice is general and won’t be suitable for everyone; which
is why it’s always a good idea to enlist the help of a good financial advisor.
I’d like to
wish all readers a joyous holiday season and a new year filled with good health,
happiness, and of course good stock market returns!
My next
article will appear on January 3, when I’ll provide a progress report on my
recommendations from this past year.
Dan Hallett, B.Comm., CFP, CFA is the Senior
Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.