CIBC sign in Toronto's financial district in downtown Toronto.The Canadian Press
Will value investing ever work again?
Canada's primary benchmark, the S&P/TSX Composite Index, is a market capitalization-weighted index, which means that price changes in larger companies affect index returns far more than smaller companies. A one per cent change in Royal Bank stock, for instance, will move the index to a greater extent than a 15 per cent change in the value of the index's smallest stock, Surge Energy.
The S&P/TSX Equal Weight Index changes all this by giving each stock in the index, regardless of size, the same influence on index returns.
The Equal Weight Index has underperformed the conventional capitalization-weighted index by a huge margin over the past three years – by about six per cent per year – and this tells us a lot about the investing environment and business conditions.
The underperformance of the Equal Weight Index first means that large-cap stocks are outperforming small-cap stocks. If small caps were rallying, the equal weight index would be outperforming because the small-cap stock appreciation carries a higher influence on returns.
The relative returns of the two benchmarks also mean that earnings growth is narrow – confined to a fewer number of larger companies rather than broad-based throughout the market.
The trend also helps explain why the value investing style is underperforming so badly. When earnings growth is limited to fewer outperforming companies, investment assets gravitate towards them, increasing their price earnings ratios beyond levels where a value-oriented portfolio manager would consider investing in them.
The value style works best when earnings growth is similar for a large percentage of benchmark stocks. In a hypothetical situation where every stock in any index was generating 10 per cent earnings growth, a value manager would outperform by buying the cheapest company by price earnings ratio – they're buying the same amount of earning growth at a lower price. The same goes for a situation when every stock has declining earnings growth – the cheaper ones will protect capital better.
Value investors will underperform until either the economy improves and earnings growth is reflected in more of the index's stocks, or the economy worsens significantly and most companies endure earnings declines together.
Three big numbers to note
2,130.82 The S&P 500 all-time high, reached in May, 2015. The index Friday closed just a hair below, at 2,129.90.
5.6% The decline in S&P 500 earnings that is expected for the second quarter vs. a year earlier, according to FactSet. That would make it the fifth straight quarterly decline, the longest streak since 2008-09.
3.5% The decline in analysts' 2016 earnings forecasts for European companies since the Brexit vote, according to Thomson Reuters data.
Stock picks
ITC Holdings Corp. As earnings season is set to start up again, this electricity transmission infrastructure company hits the top of the list of companies in the S&P 500 that show positive analyst sentiment, writes Number Cruncher columnist Ian Tam. Second and third on the list are Aflac Inc., and Comcast Corp. And attention dividend lovers, check out this screen of 11 solid Canadian dividend stocks that have positive annual cash-flow momentum and a history of increasing their dividends, among other attractive metrics.
Premier Gold Mines Ltd. The miner is on the list of some potential short-term trades for the third quarter outlined by Canaccord Genuity, writes Tim Shufelt. Canaccord believes resource cyclical sectors - in particular energy and base metals stocks - will continue to lead the market in the wake of Britain's Brexit vote. Those that may lag include food retailers, telecoms, and utilities. Other names on the list include Bankers Petroleum Ltd., Pure Multi-Family REIT, Onex Corp., Altus Group Ltd., and MAG Silver Corp.
The Rundown
The overbought and oversold
Canadian Imperial Bank of Commerce is getting close to oversold levels, writes Scott Barlow in his weekly review of the Relative Strength Index and the TSX. Canadian bank stocks rarely get oversold, and the stocks' current 5.0-per-cent yield makes it a tempting buy for many, he notes.
Index investing rises again
The S&P/TSX composite index is again outperforming the average actively managed mutual fund, writes Rob Carrick. The index made 6.1 per cent for the five months to May 31, while the average Canadian equity fund made 3.7 per cent. The index was led higher by the materials and energy sector. Rob explains why this trend is likely to stick.
Bad news investors: IPOs have vanished
There has only been two tiny IPOs in Canada in the first six months of the year worth about $1-million, compared with $1.4-billion from 13 new issues in the first half of 2015. The activity in the U.S. is off sharply as well. And despite views that IPOs often fall in value from their issue price and make poor investments, David Milstead has done some research that suggests that simply isn't the case.
A warning signal for oil
There are signs that oil refinery demand is set to fall, and that would take the price of crude with it, writes Scott Barlow. Gasoline is a key source of oil demand but right now inventories are at post-financial crisis highs.
What bearish investors are betting against
The largest short positions as of the end of June put Toronto-Dominion Bank at the top of the list, then the iShares S&P/TSX 60 Index ETF Units, then Bombardier Inc.'s B shares.
Fund managers are trouncing these ETFs
Most active high-yield bond managers have been able to beat some very popular exchange-traded funds, such as BlackRock Inc.'s $15.9-billion (U.S.) iShares iBoxx $ High Yield Corporate Bond ETF or State Street Corp.'s $11.3-billion SPDR Barclays High Yield Bond ETF. Why is this the case? Partly because junk bond ETFS are "a terrible vehicle to accumulate wealth over time."
Take a look at natural gas stocks
The focus on oil prices likely distracts investors from looking at natural gas stocks and that's a shame, writes Scott Barlow. Oil inventories are about 30 per cent above the five-year average, while natural gas is up by only 12 per cent. He used the stock of natural gas producer Tourmaline Oil Corp. to illustrate the impact on its share price compared to the level of U.S. natural gas inventories.
Don't let volatility wreck your plan
The market volatility that followed the Brexit vote means investors need to be disciplined and stick to their plan, writes Thane Stenner. Research by Vanguard found that missing just the 10 best trading days can severely hurt your returns.
The most important part of a company's earnings release
In her latest Trading Trends video, Jennifer Dowty tells investors not to get caught up with whether a company's latest quarterly earnings figure beat or met the Street. Instead, focus your attention on what the company says in the Management's Discussion and Analysis document, as that can give vital clues as to the future outlook for the company, and its stock.
Ask Globe Investor
The Question:
When a Canadian stock such as Brookfield Infrastructure (BIP.UN) pays its dividend in U.S. dollars, and you are set up for a dividend reinvestment plan or DRIP, should this be in a U.S. dollar account or Canadian dollar account? My concern is the conversion cost of U.S. dollars to Canadian dollars. I would like to avoid the conversion premium by banks.
The Answer:
If the brokerage house where you hold the shares has the option to hold investments in a U.S. dollar denominated account, then you should hold a U.S. dollar dividend paying stock in it if you want to keep the U.S. dollars. This is true irrespective if there is a dividend reinvestment plan.
-Nancy Woods, investment adviser with RBC Dominion Securities Inc.
Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.
What's up in the days ahead
Our equities analyst, Jennifer Dowty, turns her attention to the Canadian small-cap arena Monday with a detailed look at what smaller capitalization stocks analysts on the Street believe will deliver solid returns over the next year. Brenda Bouw will profile a stock that could make investors money from the growing trend of the aging population's desire to stay in their homes. And we'll welcome Larry Berman of BNN-TV fame as a regular contributor to Globe Investor. His inaugural column explores what market behaviour is telling us about the post-Brexit world.
Click here to see the Globe Investor earnings and economic news calendar.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
Click here share your view of our newsletter and give us your suggestions.
Want to subscribe? Click here to sign up or visit The Globe's newsletter page and scroll down to the Globe Investor Newsletter.
For those not already Globe Unlimited subscribers, click here to join.
Compiled by Gillian Livingston and Darcy Keith
Scott Barlow