The Globe and Mail

February 3, 2023
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The mood at the annual ‘Miami hedge fund week’ gatherings this week was as bright as the winter sunshine, with one notable dark cloud on the 2023 horizon: U.S. stocks.

The S&P 500 has just had its first January rise since 2019 - and its second best start to a year since 1989 - while the Nasdaq’s 10.7 per cent surge marked its best January since 2001. But the message from Miami was pretty clear: don’t chase the rally.

‘FOMO’ may yet set in if the move continues, and the Fed’s apparent green light on Wednesday to further upside will no doubt have unnerved some of the bears.

But right now in the hedge fund and alternative market investor community, reluctance to get sucked in is trumping fear of missing out. And there is no shortage of reasons why - inflation, weak earnings, squeezed margins, recession, ‘higher for longer’ interest rates.

An aversion to equities may come as little surprise given these investors’ bias towards the private, alternative, less liquid and more speculative parts of the investment universe that, in theory, offer higher returns.

Yet they were bullish on bonds, including Treasuries, the safest and most liquid asset of them all.

Money managers’ exposure to U.S. equities is historically low, and a ‘bullish Europe/bearish America’ narrative has gained prominence in recent weeks. According to Bank of America, investors are the most underweight U.S. stocks since 2005.

Given this stretched positioning, Wall Street’s current bounce is probably being driven by an element of short covering as much as fresh capital being poured in.

Some 3,500 people from across the investment and risk spectrum descended on the iConnections Global Alts 2023 conference in Miami this week - hedge funds, asset allocators, family offices, digital and private market participants, asset managers, wealth managers and alternatives specialists.

Money managers at some of the largest U.S. funds and investment firms overseeing trillions of dollars of assets were in attendance, and speakers included billionaire investors Mark Cuban, Jim Chanos, Marc Lasry and Kim Kardashian.

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The number of delegates was up significantly from last year’s total of around 2,300, evidence that, after a year of terrible returns for many, there is a lot of money to be put to work.

Despite massive Fed tightening and the prospect of liquidity drying up significantly this year, investors see opportunities out there. But not on Wall Street - either the market capitulates because the economy goes into reverse, or it tanks because inflation forces the Fed to keep interest rates high.

“Both roads lead to re-priced assets,” Chamath Palihapitaya, CEO of Social Capital and former Facebook executive, told the conference.

Earnings were frequently mentioned as the main reason for caution. Estimates are coming down, but not far or fast enough.

The consensus forecast for total 12-month forward earnings per share of S&P 500 companies is US$225, the lowest in a year but still near July’s all-time high of $238. Forward 12-month earnings growth estimates have fallen to 3.5 per cent from 10 per cent a year ago, but they remain positive.

This suggests equity investors are betting heavily on the Fed successfully engineering a ‘soft landing’ - possible. This is far from certain.

Yet amid the gloom, there were glimmers of positivity.

Mike Wilson, chief U.S. equities strategist at Morgan Stanley, has been one of the most vocal - and accurate - Wall Street bears over the past year.

He is still bearish in the short term, even quipping that bonds are a better buy than stocks right now. Earnings expectations will inevitably fall and the S&P 500 will re-test its October lows.

Then it rebounds.

“I think we can trade at the low 3,000s - but we won’t stay there very long. There’s too much capital out there,” Wilson said.

-- Jamie McGeever, Reuters

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Stocks to ponder

Metro Inc. (MRU-T) The grocer’s share price has plunged 11 per cent since closing at a record closing high on Dec. 9, putting it in oversold territory. However, the stock price may soon find downside support and stabilize, says Jennifer Dowty, who takes a look at the investment case.

The Rundown

Bonds beat GICs right now for investors who want to maximize returns

The bond market is already pricing in the idea that rates have peaked. This is where bonds offer some appeal over guaranteed investment certificates, which have become popular in the past year because they offer high rates and zero risk if you stay within deposit insurance limits. A bond or bond fund offers a total return based on interest plus changes in price. So far in 2023, prices are rising. Rob Carrick explains.

Why TSX investors should be cheering on the rally in emerging markets

The past three months have seen the MSCI Emerging Markets Index blast ahead of the S&P 500 and S&P/TSX Composite Index. But domestic investors shouldn’t worry about being left behind: Returns for emerging markets equities and Canadian stocks have been virtually identical over the longer term, as Scott Barlow demonstrates.

Investors are betting on a housing recovery. Is their optimism misplaced?

U.S. home-building stocks have bounced back over the past four months, suggesting that investors are looking beyond interest rate hikes and soaring borrowing costs even as the Federal Reserve raised its key rate again on Wednesday. David Berman looks at whether the rally has come too soon.

Markets to central bankers: we don’t believe you

Central bank policy announcements, once viewed as the rule book for how markets should move, are not resonating with traders any more. Take Wednesday’s Federal Reserve rate move. The central bank lifted its main funds rate by 25 bps to its highest since 2007 as it continued its fight against inflation. Yet the S&P 500 hit a five-month high, as traders focused resolutely on the idea that the world’s most influential central bank would change course soon. Government bond markets meanwhile continued to price in rate cuts by year-end as the economic cycle turns. Reuters takes a look at why there’s such a disconnect.

How to beat the pros, Part 1: Choose the right number of stocks to hold

Is beating the pros possible? You bet it is. In a new six-part series, Jason Del Vicario, CFA, portfolio manager, and Steven Chen, MBA, analyst, at HillsideWealth | iA Private Wealth Inc. will explain why - and how - a concentrated portfolio of global high-quality stocks gives the long-term investor the best chance to outperform both broadly diversified indexes as well as professional money managers. This first installment takes a look at the optimum number of stock holdings.

Others (for subscribers)

Chart analysis with Monica Rizk: Bullish on MEG Energy Corp.

Globe Advisor

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Ask Globe Investor

Question: Interest isn’t tax deductible when borrowing to invest in a tax-free savings account. But couldn’t one get around the rules by purchasing, say, a money-market fund on margin in a non-registered account and then contributing the fund in-kind to a TFSA? Then one could sell the fund in the TFSA and invest in whatever instruments one desires. Or am I missing something?

Answer: For interest to be deductible, the Canada Revenue Agency requires the borrowed funds be “used for the purpose of earning income from a business or property.” A money-market fund, dividend-paying stock or interest-bearing bond would qualify, for example. Even a stock that does not pay a dividend could meet the income test as long as the investor has a “reasonable expectation” that the investment will produce income in the future.

However, the CRA also stipulates that the income produced by the security must be taxable for the interest to be deductible. In the example you provided, income from the money-market fund – or whatever it is replaced with – would not meet this test because there are no taxes of any kind in a TFSA.

The same would be true if you purchased a security with borrowed funds, sold it to buy a different security, and transferred it to a TFSA or other registered account. “If the investment is transferred to a registered account … the interest would no longer be deductible,” said Dorothy Kelt of TaxTips.ca

The recent jump in interest rates has dramatically reduced the appeal of borrowing to invest. Even when rates are low, the strategy is appropriate only for experienced investors.

--John Heinzl (Send questions to jheinzl@globeandmail.com.

What’s up in the days ahead

There’s rising optimism about a soft landing for the North American economy. What does that means for investors? Ian McGugan will share some thoughts.

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