A slowing global economy and inflation-ignited rising bond yields are the two biggest risks to portfolio values. Commodity prices and bond proxies - defensive dividend-paying sectors like utilities and real estate that are negatively affected by rising bond yields - are the sectors the reflect these risks most clearly, and they are therefore vital for investors to follow in the coming weeks.
As trends, rising rates and slowing growth are an odd combination and one that complicates investor decision making. In normal circumstances, falling growth rates are accompanied by lower bond yields.
Crude oil and agricultural commodities have their own geopolitical and environmental dynamics but the broader commodity sector is driven primarily by global economic growth, which determines demand. Recent data have provided concerning signs of slowing growth and, predictably, commodity prices have been weak.
Released this week, the forward-looking new orders component of the U.S. ISM survey of major manufacturers came in well below consensus expectations at 53.5, not far above the 50 level that indicates a full stall-out in business activity growth.
Globally, the news is even worse, as the JP Morgan Global Manufacturing PMI index found an outright contraction in worldwide manufacturing output in April relative to March.
TD macro strategist James Rossiter described the trend in no uncertain terms on Tuesday. “Our high-frequency [economic] activity indicators are screaming ‘slowdown’ across the board,” he wrote. “Our daily global demand tracker has slipped into negative territory for the first time this year.”
Commodity prices reacted predictably to these signs of flagging growth. The S&P GSCI Industrial Metals Spot Index, for instance, is now down more than six per cent from its April 21 high and 14 per cent below the March peak.
The sharp contraction in China’s manufacturing output caused by drastic COVID-related lockdowns was the biggest detractor from global growth. The country’s demand for resources will recover as lockdowns end, but commodity prices will remain under pressure as long as global manufacturing activity slows.
The income oriented, bond proxy sectors have endured a beating of late thanks to rising bond yields. The government of Canada five year bond yield almost doubled from early March’s 1.48 per cent to the current 2.89. Risk-free bond yields have climbed to the point where they offer competition to the income available on REITs (as I wrote in a column last week) and utilities.
This competition has resulted in sharp price corrections. The S&P/TSX REIT Total Return index is down 8.3 per cent from its April 19 high and 11.2 per cent lower than the 2022 peak hit in late March, as of Tuesday’s close. The S&P/TSX Utilities index has dropped 6.1 per cent from its 2022 high, a significant move for such a defensive sector.
There are numerous ways in which the current combination of slowing growth and rising rates represent a set of handcuffs for investors looking to add to their portfolios.
Economically sensitive sectors like commodities are dangerous to buy when global manufacturing activity is fading. Defensive sectors like utilities, real estate and - a sector I didn’t mention previously - consumer staples usually outperform during slowdowns but the majority pay dividend yields and their stock prices are thus threatened by rising bond yields.
BofA Securities U.S. quantitative strategist recommended high quality health care stocks in a Wednesday research report. This makes sense and is an example of a sector that can be attractive despite current conditions. On the whole, however, allocating investment capital in equity markets will be tricky until we see a stabilization in growth rates and bond yields.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Vaalco Energy Inc. (EGY-N) In mid-2020, the Contra Guys wrote that they expected a four-bagger from this little-known energy stock. But it did far better than that - and with zero debt and much improved financials, they still expect at least a doubling from current levels.
The Rundown
The uncomfortable stock market truth: This late-pandemic crash, while painful, is necessary
No one wants to hear this, especially not someone sitting on a stock portfolio they had dreams of milking through retirement. But Tim Kiladze argues it must be said: The current market crash is necessary. And unavoidable.
Oil sands stocks are less volatile than you think. They’re stable, predictable - and immensely undervalued
Investors returning to the energy sector, perhaps for the first time in years, shouldn’t look at oil-and-gas stocks as they once did – as volatile, growth-oriented entities that live and die by the commodity boom-bust cycle. Instead, the industry mandate has become the utilization of existing assets at the lowest possible cost while siphoning profits to shareholders. Tim Shufelt explains.
Others (for subscribers)
Rob Carrick’s ETF Buyer’s Guide 2022: The complete series
Number Cruncher: How these 11 Canadian REITs stack up in terms of generating cash flow
Number Cruncher: Which of these 10 TSX tech stocks might be undervalued?
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Globe Advisor
Demand for flow-through shares to rise with new tax credit and commodities rally
U.S. regulatory scrutiny of ‘complex’ ETFs prompts fears of crackdown
Six dividend stocks with pricing power to combat inflation
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Ask Globe Investor
Question: My daughter recently started her first full-time job and she will soon have money to invest. Is there any advice you can pass along?
Answer: Yes, keep it simple. Having gone through this exercise with my university-age son recently, I know that investing can be daunting for people just starting out.
Rather than jump into individual stocks, I suggest that you consider index exchange-traded funds. Your daughter will need to open a discount brokerage account to buy ETFs, but the flexibility it provides her now and in the future will be well worth it. Index-tracking ETFs have very low costs, provide excellent diversification and may help to reduce the temptation to trade frequently that often afflicts novice investors (and even experienced ones) who buy shares of individual companies.
Since your daughter will be earning a regular paycheque, I’m assuming she’ll want to contribute to her account regularly when she’s able to save up sufficient cash. For that reason, I also recommend that she shop around for a discount broker that offers commission-free ETF purchases and sales, as many brokers do. This will slash her investing costs even further and make it economical to contribute even small amounts.
My son chose to open an account with BMO InvestorLine, which offers close to 100 ETFs with commission-free trading. He started off with two: The BMO S&P/TSX Capped Composite Index ETF (ZCN) and the BMO S&P 500 Index ETF (ZSP). The management expense ratios for ZCN and ZSP are 0.06 per cent and 0.09 per cent, respectively.
Other brokers including Scotia iTrade and Qtrade Direct Investing also offer commission-free ETF trades, and there are many other worthy index ETFs to choose from.
Perhaps the most important advice you can give your daughter is that she doesn’t need to do a lot of intensive research or become a savvy trader to build wealth. All she needs is to be diversified, reinvest her dividends regularly and let time and compounding do the heavy lifting.
--John Heinzl
What’s up in the days ahead
Boralex, the Canadian clean power producer with assets in Europe, is in the clear lead among struggling green energy stocks. David Berman takes a look at whether it will continue to be an outperformer.
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff