Foresight - Fall 2020

At writing, global stock markets are up 10-11% since our Summer Foresight and up 50% to 55% from the lows of mid-March. As governments around the globe provide massive amounts of aid and liquidity to their economies, global interest rates have moved to new lows …..again. Government of Canada 10 year bond yields are currently .55 of 1% and US 10 year Treasuries are yielding .65 of 1%. With bond yields hovering at close to zero, investors have returned to stocks with a vengeance, and global stock markets are back, or close, to record highs. As surprising as the magnitude of this rally has been in such a short period of time, we could see global stock markets grind higher still in the coming months. Leadership in this rally has been reasonably narrow with technology, ecommerce and gold stocks providing a significant amount of the appreciation. We often receive enquiries about whether a client owns a stock which has been in the news due to a run-up in its share price. While we use Exchange Traded Funds (EFT) as a very efficient, cost-effective solution to provide diversification in the equity portfolio, our portfolios do have a direct ownership in thousands of companies through those ETF holdings; in fact, in many cases, a significant weighting in the portfolios. For instance, in the Technology Sector our equity portfolios have a 2% weighting in Apple Inc, 2% in Microsoft and a 1% weighting in Alphabet (Google). The Technology sector makes up 11% of our overall equity portfolio. In eCommerce, the portfolios have a .5 of 1% weighting in Amazon and .7 of 1% in Shopify. Recently, American Barrick was in the news as Warren Buffet’s Berkshire Hathaway (famously anti-gold!) announced buying a position in the gold producer. Our overall equity portfolio has a 1.1% weighting in American Barrick. We remain defensive in these uncertain economic times, with our equity portfolios holding 10% weighting in Canadian Banks—Royal Bank of Canada  (3.1%), Bank of Nova Scotia (3%), Bank of Montreal (2.4%), Toronto Dominion Bank (1.5%), CIBC (.5 of 1%)—and an overall weighting of approximately 24% in global Financial Services companies.

Although we are enjoying the recent Bull Market run in global equities, we are concerned that at some point, likely prior to a successful discovery of a Covid -19 vaccine, global equity markets will go through a “worry” phase resulting in a correction. The issue is when and from what level? As we noted in our Summer Foresight, after selling fixed income (bonds) and buying equities from mid-March to early April, we were surprised to see equity markets rebound 40% in two short months... and then rise a further 10% from those levels. Presently, we continue rebalancing portfolios monthly to keep them in line with their asset allocation plans. As we did through the very long Bull Market of 2009 to 2020, we are rebalancing by selling down equities as markets rise, and awaiting the opportunities that corrections/Bear Markets  provide to buy stocks “on sale”. 

We go “under the hood” to give you more information about various equity stock baskets that you may own. This will help you to understand “portfolio construct”…. how the sum of many parts make up the whole, to create a coherent investing strategy in the global stock markets.

Amongst other considerations, our equity selections simultaneously address twin strategies of business sectors and global dispersion, both of which we track monthly, and share with you in your Annual Report. Our equity baskets are mostly direct company stock holdings and exchange-traded funds (ETFs), with few mutual funds, in order to a) minimize your investing costs and b) enable us to actively manage passive baskets of holdings. In selecting ETFs, we utilize two strategies...using the metaphor of a rifle and a shotgun; the former aims at a particular target and the latter aims simultaneously at multiple targets. For instance, there are ETFs that target the entire world of stock markets and others that target, for example,

only Europe. There are ETFs that target an entire economy and others that target, for example, only the financial sector. By utilizing both “rifles” and “shotguns”, when we need to rebalance your equity portfolio in response to market conditions, we have the tools to be very precise...or broad. This applies whether we are selling in a surging market (like Summer 2020), or buying in a down market (like Spring 2020). 

The following chart shows the Global sectoral weightings as of June 30, 2020 on the top row. Below that, we highlight various regions and, specifically, only identify where their industrial allocations are notably different from the global ones. 

	Resource	Utilities	Industrial	Cons- umer	Communication	Finance	Health	Tech	Misc
Global	8	3	10	19	10	14	14	20	2
Canada	28			8		33	1	10
US
Europe	12			24	5		18	7
Emerging	13					22	4	13
Japan			23	23			6	10

The most notable variations from the global weightings include:

	Domestic %	Global %		Domestic %	Global %
Canada resources	22	8	Canada consumer	8	19
Canada finance	33	14	Europe technology	7	20
Canada health	1	14	Japan industrial	23	10
Canada technology	10	20

As you can see, our investing home turf of Canada is a notable outlier in five of the eight sectors-over in two and under in three! Any and all of these sectors can take their turn in the lead and limelight of huge returns. Canada-only investors would leave those returns on the table in health, technology and consumer discretionary. Venturing outside our borders to enjoy those sector returns requires transacting in foreign currencies, notably USD. The loonie’s fluctuations with world currencies can be significant and volatile….adding to, or subtracting from, the sectoral returns.    

We analyze and report foreign exchange impact annually in our Spring issue. Note that there are no cited notable variations along the “US” row on the Table. This is because the US market presently makes up such a large proportion of the global market.

The Resource sector

Under the hood, this sector is more complex because it includes many, different things, eg gold, silver, chemicals, copper, oil & gas, uranium, and other metals. We buy the ETF symbol XEG as well as USO and IXC which specifically invest in the oil and gas energy sector, domestically and globally. We buy the ETF symbol XMA domestically, which includes 42% gold, 7% silver 24% chemicals, 10% metals & mining and 7% copper. We also buy MXI globally, which includes 52% chemicals and 33% metals & mining. We also buy XBM which invests globally 36% in copper and 54% in metals & mining. We buy gold bullion directly through symbols GLD, IAU and PHY, as well as gold exploration companies, which we track separately, apart from the Resource sector.

The Financial sector

This sector is comprised of banks, insurance companies and diversified financial companies, eg mutual fund companies. Much of our Canadian holdings is in the iShares TSX Capped Financials Index ETF (XFN), which is reasonably concentrated with only 25 holdings, of which 66% is banks, 20% insurance companies and 14% diversified financials. We recently have been buying Canadian banks directly, including Bank of Montreal, Royal Bank of Canada, Bank of Nova Scotia and Toronto Dominion Bank, for their very attractive current dividend yields, depressed share prices and track record of long-term dividend growth. Historically low interest rates continue to be a major drag on insurance company earnings, and we prefer to underweight this sub-sector of Financial Services until we see a sustainable trend for higher interest rates.

Globally, our financial sector holdings are split largely between the United States and Europe. In the U.S. we hold the SPDR Financial Select Sector ETF (XLF) and the iShares U.S. Financials ETF (IYF). We also have direct holdings in Bank of America and Berkshire Hathaway.  In Europe we hold the CI First Asset European Bank ETF (FHB) and the iShares European Financials ETF (EUFN). We also have a small exposure to Emerging Markets Financial Services companies through our diversified Emerging Market ETFs which have a 22% weighting in this sector. 

The Health sector

As noted in the Tables, the health sector in Canada is practically non-existent. Thus, we must invest strictly abroad to fulfill the target for health. We rely particularly on two global healthcare ETFs, the iShares Global Healthcare Index ETF US$ (IXJ) and the iShares NASDAQ Biotechnology ETF US$ (IBB). We also use the iShares Global Healthcare ETF (XHC) traded on the TSX in Canadian dollars to hedge out the currency risk of IXJ. The only holding in XHC is IXJ.  IXJ has 108 holdings with 63% in Pharma, Biotech and Life Sciences companies and 34% in Health are Equipment and Services companies. Two thirds of the ETF is invested in U.S. companies, 10% Switzerland, 7% Japan with the balance largely the rest of Europe and the United Kingdom. Holdings in IXJ/XHC include Johnson & Johnson, Unite Health Group, Roche, Novartis, Merck, Pfizer, ABBVIE and Abbott Laboratories. IBB is 100% U.S. Biotechnology and pharmaceutical companies. Holdings include Amgen Inc, Vertex Pharmaceuticals, Gilead Sciences, Regeneron Pharmaceuticals, Illumina, Biogen and Seattle Genetics. We also make some direct buys of shares in pharmaceutical companies.

 The Consumer sector

This sector is divided into two sub-sectors: Discretionary and Staples, which target very different segments of the “consumer’s wallet”.  The Discretionary sub-sector includes companies providing non-essential goods and services including, inter alia, automobiles, apparel and media companies. This include companies like Amazon, Home Depot, McDonalds, Nike, Lowes Starbucks and Toyota. The Staples sub-sector includes companies providing essential products and services, like food and household items. This includes companies like Home Depot, Walmart, Phillip Morris, Costco, Coca-Cola, Pepsico, Diageo, Proctor & Gamble and Nestles. You may note that all of these names are large, global business entities. We fulfill our target allocation in the Consumer sector almost exclusively to foreign equities, as the Canadian market in this sector is very small (see graph on inside page). We view the Discretionary sub-sector as appropriate for the growth phase of the economic cycle and have focused our holdings to this sub-sector over the last eight years. In the event that we become defensive in our economic outlook for the medium term, we will consider re-balancing from Discretionary to Staples as a tactical move. Over the last ten years, the Discretionary subsector has outperformed the Staples sub-sector by 3.3% per annum: a significant outperformance, as a $10,000 investment in the iShares Discretionary ETF (RXI) would be worth $33,408 after 10 years, versus $24,646 for the Staples ETF (KXI).

The Utilities sector

This sector is comprised of gas and electric utilities (including renewable electricity from run of river, wind and solar) and independent power producers. Approximately 70% of our Utilities sector exposure is made up of Canadian equities through the ETF iShares TSX Utilities (XUT) and various direct Canadian holdings like Innergex Renewable Resources, Brookfield Renewable Partners, Brookfield Infrastructure Partners, Canadian Utilities and Fortis Inc. Significant holdings in XUT include, Fortis, Brookfield Renewable Partners, Brookfield Infrastructure Partners, Hydro One, Emera, Algonquin Power, Northland Power, Altagas and Canadian Utilities. Direct exposure to the Utilities sector in Foreign equities is mostly comprised of the iShares Global Utilities ETF (JXI), which is primarily comprised of electric (58%), gas (6%) and water (3%) utilities and multi-utilities (31%). Significant holdings in JXI include Nextera Energy, Iberdrola SA, Dominion Energy, Enel, Duke Energy, Southern National Grid and American Electric Power. Regionally, JXI is weighted 58% in the U.S. with the balance being primarily in Europe.

    The Communication & Technology sectors

In the Fall of 2018, the Global Industrial Classification System (GICS) was overhauled. Many large, global companies were shifted from one sector to another based upon the current view of their business activities. Notable companies that moved from technology to communication included Alphabet (Google), Facebook, Electronic Arts, Twitter and Take Two Interactive. Other companies moved from consumers to communications, including Comcast, Walt Disney, Netflix, Fox, CBS and Viacom.  Lastly, eBay was moved from technology to consumers.

Like the health sector, Canada has a miniscule presence in technology; thus we fill this sector globally, with the ETF IXN and with individual holdings.

On the other hand, Canada’s communications sector includes many well known names, including Telus and BCE. Globally, we fulfill this sector with the ETF IXP.