Aerial drone view of a wind farm on the Atlantic coast. Image courtesy BMO ETFs/Getty Images
By Andrew Vachon, BMO Global Asset Management
The Bank of Canada (BoC) cut rates on June 5th for the first time after one of the most aggressive hiking cycles in Canadian history.
Market expectations from the BoC indicate that we may see 2 to 3 more cuts before the end of the year with the second cut potentially as early as July and the remaining later in the year.
South of the border, inflation has remained “stickier” however; the market expects the U.S. Federal Reserve (the Fed) to cut rates twice before the end of the year with the first beginning in September. Moreover, forecasters are predicting the BoC could potentially cut the overnight rate from the current rate of 4.75% all the way down to 3.5% by this time next year, presenting more opportunity for the Utilities sector. 1
With the anticipation of further rate cuts from the BoC and the Fed we may see the Utilities sector shine. Government bond yields tend to have an inverse relationship with utilities (when interest rates drop, utility stock prices typically increase, and vice versa). This is mainly due to the costs involved with these companies. The cost of construction for power plants, and the maintenance of infrastructure required to deliver gas, water, or electricity can make utilities expensive when the cost of borrowing is high.
From a technical perspective, the BMO Equal Weight Utilities Index ETF (Ticker: ZUT) just broke out of a massive “double bottom” reversal pattern this week. A double bottom pattern is a classic technical analysis charting formation showing a major change in trend from a prior down move. The recent close above resistance at $20.60 completed the pattern, shifted the long-term trend to bullish, and opened an initial upside target that measures to $23.40.
One of the key drivers for the turnaround in utility stocks as of late is a sharp decline in long-term interest rates. There is now a possibility of yields testing the lows of 2023, which could be a persistent tailwind for interest rate sensitive sectors of all stripes and perhaps push this Utility ETF above the initial upside target of $23.40 at some point in the next 6-12 months. 2
Yielding the Benefits
For the long-term investor, Utilities offer investors stable and consistent dividends over time along with lower volatility. The long-term growth potential to deliver safe and reliable returns, make the sector an attractive investment to consider adding to your portfolio. Utilities overall have remained fundamentally strong as they provide basic services such as gas, water, electricity and telecommunications that will always be in demand regardless of where we are in the economic cycle.
There are long-term benefits for Canadian investors, especially those who might consider the current environment as an opportunity to capture growth. Continue Reading…
The United States stock markets have delivered positive returns through much of 2024, continuing the positive momentum that was established in the previous year.
However, that performance has increasingly been powered by a smaller segment of large-cap companies. Indeed, readers have undoubtedly heard about the outsized performance of the “Magnificent 7” in the tech space over the past year. If we strip out the “big six” of Amazon, Meta, Nvidia, Microsoft, Apple, and Alphabet from the S&P 500, we have experienced three calendar quarters of negative earnings growth across the rest of the market.
Investors took profits in the month of April. Demand resumed in the month of May, but with a broader range of equities. Nvidia continued to show its dominance, but there were other sectors and stocks that were able to catch up with the leaders to close out the first half of 2024.
The summer season is historically slow in the markets. Harvest’s portfolio management team expects volatility to persist for both bonds and equities. Moreover, the team emphasizes that this summer is a key moment to stay active, attentive, and invested. A prudent strategy in this environment involves looking under the surface for opportunities while generating cash flow from call options to support total returns.
June Healthcare check up
The healthcare sector pulled back slightly in the month of May 2024. Negative moves in the healthcare sector over the course of May 2024 were driven by stock specific events. Macroeconomic data sets impacted the healthcare sector in line with others. Within healthcare, the managed care subsectors experienced volatility earlier in 2024 and changes to reimbursement structures impacted valuations in the near term. The Tools & Diagnostics sub-sector has also proven volatile due largely to a slower-than-expected recovery in China.
Regardless, there are still very promising opportunities in the GLP-1 drug category space for diabetes and obesity. The uptake of these drugs in the U.S. has been significant at a still-early stage in their lifespan. A recent study from Manulife Canada found that drug claims for anti-obesity medications in Canada rose more than 42% from 2022 to 2023.
Harvest Healthcare Leaders Income ETF (HHL:TSX) offers exposure to the innovative leaders in this vital sector. This equally weighted portfolio of 20 large-cap global Healthcare companies aims to select stocks for their potential to provide attractive monthly income as well as long-term growth. HHL is the largest active healthcare ETF in Canada and boasts a high monthly cash distribution of $0.0583.
Harvest Healthcare Leaders Enhanced Income ETF (HHLE:TSX) is built to provide higher income every month by applying modest leverage to HHL. It last paid out a monthly cash distribution of $0.0913 per unit. That represents a current yield of 10.44% as at June 14, 2024.
Where does the technology sector stand right now?
Investors poured back into technology stocks in May 2024 after taking profits in the month of April. However, they were more discriminating than in previous months and showed a preference for hardware stocks, specifically semiconductors.
Nvidia maintained its leadership position. It has soared past a $3 trillion market capitalization in the first half of June 2024. However, other AI-related tech stocks encountered turbulence which may give some investors pause around the broader bullish case for AI. Continue Reading…
Come gather ’round people Wherever you roam And admit that the waters Around you have grown And accept it that soon You’ll be drenched to the bone If your time to you is worth savin’ And you better start swimmin’ Or you’ll sink like a stone For the times they are a-changin’
In this month’s commentary, I will discuss both how and why the environment going forward will differ markedly from the one to which investors have grown accustomed. Importantly, I will explain the repercussions of this shift and the related implications for investment portfolios.
The Rear View Mirror: Where we’ve been
After being appointed Fed Chairman in 1979, Paul Volcker embarked on a vicious campaign to break the back of inflation, raising rates as high as 20%. His steely resolve ushered in a prolonged era of low inflation, declining rates, and the favourable investment environment that prevailed over the next four decades.
Importantly, there have been other forces at work that abetted this disinflationary, ultra-low-rate backdrop. In particular, the influence of China’s rapid industrialization and growth cannot be underestimated. Specifically, the integration of hundreds of millions of participants into the global pool of labour represents a colossally positive supply side shock that served to keep inflation at previously unthinkably well-tamed levels in the face of record low rates.
It’s all about Rates
The long-term effects of low inflation and declining rates on asset prices cannot be understated. According to Buffett:
“Interest rates power everything in the economic universe. They are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that’s a huge gravitational pull on values.”
On the earnings front, low rates make it easier for consumers to borrow money for purchases, thereby increasing companies’ sales volumes and revenues. They also enhance companies’ profitability by lowering their cost of capital and making it easier for them to invest in facilities, equipment, and inventory. Lastly, higher asset prices create a virtuous cycle: they cause a wealth effect where people feel richer and more willing to spend, thereby further spurring company profits and even higher asset prices.
Declining rates also exert a huge influence on valuations. The fair value of a company can be determined by calculating the present value of its future cash flows. As such, lower rates result in higher multiples, from elevated P/E ratios on stocks to higher multiples on operating income from real estate assets, etc.
The effects of the one-two punch of higher earnings and higher valuations unleashed by decades of falling rates cannot be overestimated. Stocks had an incredible four decade run, with the S&P 500 Index rising from a low of 102 in August 1982 to 4,796 by the beginning of 2022, producing a compound annual return of 10.3%. For private equity and other levered strategies, the macroeconomic backdrop has been particularly hospitable, resulting in windfall profits.
From Good to Great: The Special Case of Long-Duration Growth Assets
While low inflation and rates have been favourable for asset prices generally, they have provided rocket fuel for long-duration growth assets.
The anticipated future profits of growth stocks dwarf their current earnings. As such, investors in these companies must wait longer to receive future cash flows than those who purchase value stocks, whose profits are not nearly as back-end loaded.
All else being equal, growth companies become more attractive relative to value stocks when rates are low because the opportunity cost of not having capital parked in safe assets such as cash or high-quality bonds is low. Conversely, growth companies become less enticing vs. value stocks in higher rate regimes.
Example: The Effect of Higher Interest Rates on Value vs. Growth Companies
The earnings of the value company are the same every year. In contrast, those of the growth company are smaller at first and then increase over time.
With rates at 2%, the present value of both companies’ earnings over the next 10 years is identical at $89.83.
With rates at 5%, the present value of the value company’s earnings decreases to $69.91 while those of the growth company declines to $64.14.
With no change in the earnings of either company, an increase in rates from 2% to 5% causes the present value of the value company’s earnings to exceed that of its growth counterpart by 9%.
Losing an Illusion makes you Wiser than Finding a Truth
There are several features of the global landscape that will make it challenging for inflation to be as well-behaved as it has been in decades past. Rather, there are several reasons to suspect that inflation may normalize in the 3%-4% range and remain there for several years.
In response to rising geopolitical tensions and protectionism, many companies are investing in reshoring and nearshoring. This will exert upward pressure on costs, or at least stymie the forces that were central to the disinflationary trend of the past several decades.
The unfolding transition to more sustainable sources of energy has and will continue to stoke increased demand for green metals such as copper and other commodities.
ESG investing and the dearth of commodities-related capital expenditures over the past several years will constrain supply growth for the foreseeable future. The resulting supply crunch meets demand boom is likely to cause an acute shortage of natural resources, thereby exerting upward pressure on prices and inflation.
The world’s population has increased by approximately one billion since the global financial crisis. In India, there are roughly one billion people who do not have air conditioning. Roughly the same number of people in China do not have a car. As these countries continue to develop, their changing consumption patterns will stoke demand for natural resources, thereby exerting upward pressure on prices.
Labour unrest and strikes are on the rise. This trend will further contribute to upward pressure on wages and prices.
A Word about Debt
The U.S. government is amassing debt at an unsustainable rate, with spending up 10% on a year-over-year basis and a deficit running near $2 trillion. Following years of unsustainable debt growth (with no clear end in sight), the U.S. is either near or at the point where there are only four ways out of its debt trap:
Small businesses play a sizeable role in shaping Canada’s economy, contributing significantly to national employment numbers and our country’s gross domestic product (GDP).
According to Statistics Canada, in 2022 businesses with 1 to 99 employees made up 98 per cent of all employer businesses in this country. But today’s economic environment has triggered new financial challenges for this cohort. Canadian entrepreneurs can help offset the cost of rising inflation, rising cost of inputs, and rising interest rates, and keep more money in their pockets, by adopting some or all of these key tax strategies.
Consider employing your immediate family
Income splitting, whereby the higher-earner transfers part of their income to a lower-earning family member, can reduce the tax owed by your household. Consider paying a reasonable salary to your spouse and/or children for the services they provide for your business to reduce your tax obligations.
Incorporate your business
If your business generates more profit than you need to live on, incorporation is a highly effective tax strategy. It could lead to a significant tax deferral by qualifying for the lower small business tax rate for active income – the longer the profits are left in the company, the larger the tax deferral. If shares of the business are ultimately sold and are eligible for the lifetime capital gains exemption, the tax deferral gained through incorporation can create a permanent tax saving.
Other potential advantages of incorporation include having family members own shares (so as to have access to multiple capital gains exemptions) and possibly paying out dividends to actively participating family members who are taxed at a lower rate.
Maximize tax breaks with registered plans
Consider your RRSP contribution room when setting and reporting remuneration for services provided by yourself and family members who also work in the business. Employment income creates RRSP contribution room for the following year which, for 2024, can represent up to $31,560 of room. RRSP contributions are tax deductible, provide tax deferral and allow for business owners to diversify their future retirement income. Contributing to a tax-free savings account (TFSA) can also work in your favor by allowing you to withdraw funds if needed without penalty. Continue Reading…
If you had told me in my early twenties that I’d be already planning for retirement before my first major job promotion, I might have laughed it off.
Like many young professionals, I was more concerned with navigating the beginnings of my adult life and my first ‘real’ job than retirement, far in the future.
However, a deep dive into the financial world revealed the concept of ‘Financial Independence’ or ‘Findependence,’ a state where you have sufficient personal wealth to live without having to work actively for basic necessities. Essentially, what it means is that you can retire way earlier than what society considers ‘retirement age’ and enjoy your retirement while you’re still relatively young.
Today, as I share my experiences and the strategies that I’ve learned along the way, I hope to inspire you to start thinking about retirement sooner rather than later. After all, achieving financial independence is not just a goal; it’s a journey that offers profound peace of mind.
Start Early and Embrace the Power of Compound Interest
Let’s talk about the first and most important strategy I adopted; harnessing the power of compound interest.
Compound interest is like a snowball rolling downhill; as it rolls, it picks up more snow, growing bigger and faster. When you save money, compound interest works by earning interest on both your initial amount and the interest already earned.
This means your money grows faster over time. For example, investing just $200 a month starting at age 25 could grow to more than $500,000 by age 65, assuming an average annual return of 7%.
Diversify your Investment Portfolio
Diversification is key to managing risk and maximizing returns over the long term.
I’m going to say it again … DO NOT invest all of your money in one single asset!
My approach has been to spread investments across a variety of asset classes including stocks, bonds, real estate, and even some alternative investments like cryptocurrencies.
But again, if you spread your investments into too many different assets, the profit you might obtain from each investment could become very small and not that significant. So, not too many but also not too few.
Take advantage of Tax-Efficient Accounts
In both Canada and the U.S., you can take full advantage of tax-advantaged retirement accounts. How? Let me elaborate.
In Canada, utilizing the RRSP (Registered Retirement Savings Plan) and the TFSA (Tax-Free Savings Account) can significantly enhance your savings growth by deferring taxes or allowing tax-free gains.
In the U.S., similar benefits are offered through IRAs (Individual Retirement Accounts) and 401(k)s.
The amazing thing about these accounts is that they not only reduce your tax liability but also allow your investments to grow unhindered by taxes, which can make a substantial difference over the decades.
Consider Real Estate Investments
When talking about investments, it’s impossible to leave out investing in Real Estate.
Real estate can be an excellent addition to any retirement strategy, offering both capital appreciation and potential rental income. Continue Reading…
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