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For the first time since 1999, current U.S. market valuations imply negative average annual returns for the next decade, according to BofA Securities U.S. quantitative strategist Savita Subramanian.

Ms. Subramanian uses six inputs to determine a fair value for the U.S. equity market as a whole: normalized earnings, risk free bond yields, expected long term inflation rates, equity risk premium (equity earnings yield relative to bond yields), corporate cost of capital and forward price to earnings ratios.

Based on this fair value assessment, the strategist finds the S&P 500 is 35 per cent overvalued. Using all 10-year periods since 1987 for precedent, this indicates an average annual return of -0.5 per cent for the next decade. The last time the model predicted 10-year negative average annual returns was 1999.

To state the obvious, negative forward returns does not mean every stock in the S&P 500 falls for the period. It usually means that the winners from the previous period, those that came to dominate the benchmark in terms of market capitalization, deflate and new winning sectors emerge.

If we look at the five-year period from the peak of the technology bubble in March 2000, it’s not hard to see the tech implosion. Communications equipment stocks fell 90 per cent and the S&P 500 Application Software index cratered 73 per cent. At the same time, however, U.S. homebuilder stocks climbed fivefold, the fertilizer and agricultural chemicals sector jumped 276 per cent and oil and gas refiners climbed 261 per cent.

Until new sector leadership becomes clearer, Ms. Subramanian is recommending dividend income. “We see dividend preservation and growth as the single most important criteria for stock selection,” she writes. “[This] could potentially be the difference between a flat-to-negative and positive return over the next 10 years.”

Specifically, BofA advises stocks representing ‘inflation-protected yield’, and the strategist provided a longer list of 45 candidates within this theme that I posted on social media here. Those likely to be of interest to Canadian investors (although they will need to be careful about tax treatment) include Best Buy Co. Inc., Celanese Corp. A, Blackrock Inc., Comcast Corp., Cisco Systems Inc., Eastman Chemical Co., JP Morgan Chase & Co., LyondelBasell Industries, Newmont Corp., QUALCOMM Inc., Sysco. Corp., Texas Instruments Inc., and Union Pacific Co.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Computer Modelling Group Ltd. (CMG-T) Benj Gallander and Ben Stadelmann (AKA “The Contra Guys”) believe this Canadian software provider that has traded since 1997, and that now has 617 oil and gas clients, is a good contrarian stock to sock away in your TFSA. The stock pays a handsome dividend and is down in the dumps. The bet here is that oil and gas corporations must invest in order to produce - and this is a company that will eventually benefit.

CK Hutchison Holdings Ltd. (CKHUY-OTC) Without a doubt there are many risks around investing in China. What a value investor tries to do is find companies tarnished but not completely at risk in such situations. This is one such company, according to fund manager Tim McElvaine. He calls it a world-class company with modest debt, thoughtful management, an attractive dividend - and a stock price too cheap to ignore.

The Rundown

‘We’ve maxed out our TFSAs, RRSPs and RESPs - now what?’

The bizarro world of pandemic personal finance brings us a question that gets asked very little in normal times: What to do after you’ve exhausted all the tax-sheltered savings opportunities? Rob Carrick answers.

Short sales on the TSX: What bearish investors are betting against

Do you own any shares in the following companies: Lion Electric Co., Hut 8 Mining Corp., Goodfood Market Corp., TMC The Metals Co. Inc., Peak Fintech Group Inc., Lightspeed Commerce Inc., Flora Growth Corp., Air Canada or Canadian Pacific Railway Ltd.? If so, you may want to double-check your buy-and-hold thesis. Short-selling activity has recently become elevated in these stocks, which academic studies warn may foreshadow underperformance. Larry MacDonald breaks down the latest findings when it comes to short selling on the TSX.

Three TSX-listed laggards with upside potential

The S&P/TSX Composite Index has returned 24.1 per cent since the end of 2019. Certainly not all the companies that make up the country’s top benchmark have experienced share gains equally. Fifty-five members of the S&P/TSX have netted negative returns since Dec. 31, 2019. According to AGF Investments fund manager Mike Archibald, there are at least a few among the losing pack that seem well-positioned for strong upside as the recent surge in COVID-19 variants peaks in most parts of the developed world and the economy continues to grow in their absence.

The 1970s all over again? Stagflation debate splits Wall Street

Most economists believe stagflation - rising inflation and slowing economic growth - is far from inevitable, and the Federal Reserve has said rising prices will prove temporary. Yet many investors are on alert, wary of the corrosive effect that past periods of stagflation have had on asset prices. Google searches for “stagflation” this month are on track to hit their highest level since 2008, while Goldman Sachs wrote the term is now “the most common word in client conversations.” The number of fund managers expecting stagflation rose by 14 percentage points in October to the highest level since 2012, a survey from BoFA Global Research showed. David Randall of Reuters reports.

Also see: The U.S. bond market says inflation will last. You should be listening

Others

Tuesday’s analyst upgrades and downgrades

Wednesday’s analyst upgrades and downgrades

Tuesday’s Insider Report: Chairman invests $715,000 in this penny stock that’s spiked over 70% in the past month

Number Cruncher: Twenty U.S. growth stocks with high reinvestment rates and earnings momentum

Globe Advisor

Two fund managers look beyond the headlines for direction on China

Stack Capital aims to give average investors access to private equity

Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.

Ask Globe Investor

Question: What do you think of ZWT, issued by Bank of Montreal? Should we understand that they use cover calls to generate income and finance their interesting distribution of 4.5 per cent? How does the use of covered call options help in mitigating downside risk (as they say in the documentation)?

I understand that when you sell covered calls, you will be obligated to sell the stock at a certain price if it goes up. But when the value decreases, nobody will buy. To protect against a market decrease, don’t we need a put option?

Answer: ZWT-T is the trading symbol for the BMO Covered Call Technology ETF. It invests in securities of technology and technology-related companies in addition to writing covered call options to generate cash flow. The premiums received from the option writing provide the downside protection BMO refers to, but it’s very limited.

If the price of an optioned stock goes down, the option expires worthless and a new one can be written.

This is a new fund, launched in late January, so we don’t have any historical data to compare it with similar ETFs. It’s also expensive, with a management expense ratio of 0.73 per cent.

The Harvest Tech Achievers Growth and Income Fund (HTA-T) has a similar mandate. It posted a one-year gain of 39 per cent to the end of September. It’s also expensive, with a management fee of 0.85 per cent.

You can also look at the CI Tech Giants Covered Call ETF (TXF-T). It has a lower management fee than the Harvest fund at 0.65 per cent but its recent returns are not as strong.

--Gordon Pape

What’s up in the days ahead

Are we on the cusp of a major boom in higher dividend payouts? Tim Shufelt will report.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff

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