Rolling the dice on multiple levels

Rolling the dice on multiple levels, that truly is the current state of affairs. From both a health and economic front that is exactly what we are doing – where we do not want to do that is your investment portfolios. For retirees/investors looking for capital preservation and for many of those same people who have higher potential mortality rates to COVID 19, it is an unsettling combination. The risk of reinfection, or Round 2 of the COVID 19 virus has indeed altered our daily lives, the economy and in turn how our team has positioned your portfolios. Not only are we tasked with participating in the rally, but also finding large/mid cap strong dividend paying stocks, all while being able to reverse course on a dime should the virus re-emerge and force the economy to shut down yet again.

If one were to do a deep dive into the North American equity markets you will see that the TSX index is down approximately 12.8% year to date, and the S&P is down approximately 11.1%. Both results have been largely driven by a handful of story stocks: Tesla, Netflix, Apple, Shopify ($22.9 million in quarterly earnings and a market cap bigger than Royal Bank- quite the bag of magic beans if you ask me) to name a few. In 2008, one of the key factors that caused a collapse in the housing market was what was commonly referred to as NINJA mortgages (No Income, No Job or Assets), fast forward a few years and we have a similar situation in stocks. Now take a look at the Equal Weight Indexes (an equalweighted index is a stock market index that is comprised of a group of publicly traded companies that invests an equal amount of money in the stock of each company that makes up the index). The TSX Equal Weight Index is down approximately 17.8% year to date, while the S&P Equal Weight Index is down 16.1%.  That means that a select group of stocks is pushing the indexes higher at this point.

Now let us drill down a level even further and look at Exchange Traded Funds (ETFs).  ETFs are essentially “baskets” of stocks with various characteristics.  In the case of client portfolios these baskets contain strong dividend paying stocks in both Canada and the US. These baskets contain for the most part the exact dividend paying stocks (banks, pipelines, utilities, consumer staples, REITS, Energy) that we typically look to own throughout an entire market cycle. The ones we usually get excited over the prospect of owning when they are on sale (they are now) and with dividend yields of 6%. Power Shares Canadian Dividend ETF (PDC), which owns a “basket” of dividend paying stocks in Canada, is down 21.9% year to date. The Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), which owns a “basket” of dividend paying stocks in the US, is down 29.5% year to date. Please keep in mind that we did not own these on the way down, we invested in them at these discounted prices.

What does this all mean? It means that the rally has been very selective (Netflix, Amazon, Google, Shopify etc.) and as a result, strong dividend paying stocks in North America are trading at a discount given that they have not participated in the rally to the same extent as the handful of aforementioned story stocks. It means that the types of stocks that our client base typically seeks to purchase and hold in their accounts are still arguably on sale. The next question we need to ask ourselves is why are we talking about ETFs and not the individual stocks? Well the answer again lies in the details and the dice…. We have made the strategic decision to invest in these types of ETFs for multiple reasons:

  1. They are a shotgun approach (basket) of high quality names in desired sectors, with the dividend characteristics we are seeking.
  2. They are liquid meaning that we can quickly reverse course (due to a second wave of COVID 19, or any other reason).  This will allow us to effectively risk manage your accounts by quickly reducing equity exposure in a few quick trades. Currently, if our PIVOT model turns negative, we can reduce 40-50% of equity exposure in a matter of minutes.
  3. Given the diversification of the investments within these ETF units, they are relatively insulated from individual company dividend cuts, or poor quarterly performance. If you own an individual company and they choose to cut or eliminate their dividend in this environment, not only have you lost your yield,  but the share price will typically decline a noticeable amount. In the ETF’s should one or two of the companies inside the ETF cut or eliminate their dividend, you will see less of an impact on the average yield and on the unit price.  The adage of putting all your eggs in one basket applies.

As the economy re-opens and impacts the markets, our objective is to participate, yet be guarded and cautious. At the moment, think of the ETFS as your investing face mask. We will participate in the re-opening.  Should all go well we will actively participate (lots of upside as these ETFs are still down significantly year to date) and we will generate the yield level that clients are looking for in their portfolios. Should things get worse and the population, economy and markets suffer further negative impacts from COVID 19, the ETFs in combination with PIVOT will help us risk manage and protect client capital.

I hope that this note provides some insights relating to current portfolio positioning. As always should you have any questions, please feel free to phone or email one of us.

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