The Year to Date
Stock markets have been very strong this year to date. The S&P 500 is up 15.4% and the Toronto stock index is up 8.3%.
A standard globally diversified portfolio with a standard mix of 60% equities and 40% fixed income is up about 6.9% (VBAL) or 7.5% (XBAL).
In all cases here, dividends would add somewhat to the gains.
State of the Economy
The U.S. economy has continued to be strong with very low unemployment levels and strong GDP growth.
The Canadian economy is relatively weak with rising unemployment levels.
Interest Rates
The market consensus is that on Wednesday July 24th, the Bank of Canada will cut interest rates for the second time this year and follow this up with two more cuts by the end of the year. The U.S. FED is expected to make its first interest rate cut in September and cut once or twice more by year end.
What could go wrong?
There are many things that could send markets lower. Some that come to mind are:
- The valuation of the S&P 500 is somewhat rich. The trailing unadjusted actual price/earnings ratio is currently quite elevated at 28.6. The forward p/e based on actual expected GAAP earnings in the next year is also elevated at 23.8. The forward p/e based on forecast operating earnings – which is what most analysts focus on – is also somewhat elevated at 21.6. It’s certainly possible that the continued strong earnings of the big tech stocks will justify this high valuation, but it leaves the market vulnerable to a pullback.
- Recessions in both Canada and the US are possible, perhaps even likely. The goal of higher interest rates has been to cool the economy, so we should not be surprised if that succeeds. In Canada we face the added negative impact of so many mortgages renewing at higher interest rates.
- A Democratic Party win in November could be negative for markets given their plans to increase both corporate income taxes and taxes on higher personal incomes. Some of Trump’s personal tax cuts will expire in 2025 unless extended.
- A Trump win in November could also be negative for markets given his plans to erect higher tariff walls.
- Geopolitical risks are always a possibility including conventional wars, trade wars, and even possible threats of nuclear wars.
What to do?
Given uncertainties, it’s prudent for investors to include geographic diversity in their portfolios and to include fixed income as well as equities.
It may be a particularly good time to lock in today’s yields on fixed income given that interest rate are expected to decline. I’ve just updated my article on Fixed Income Choices which includes simple high interest savings accounts paying 4.3% in Canada and 4.9% on U.S dollar savings and also includes information on GICs.
At this time I think perpetual preferred shares are attractive. They mostly yield 6.0 to 6.4% and in addition they should offer capital gains if interest rates fall as expected. They are eligible for the Canadian dividend tax credit. These can be a great choice for a portion of portfolios of older investors or anyone seeking dividend income. I have six of these on our list rated “Buy” or (higher) Buy. To see the list you can Subscribe at a cost of just $15 per month or $150 per year. To Subscribe click “Become a member” at the top of any page of this website.
And if you are looking for a REALLY simple solution, and not interested in investing in individual stocks, you can invest in VBAL or XBAL on Toronto which will give you a prudent standard balanced and diversified portfolio at a very low management fee.
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Shawn Allen
Investorsfriend Inc.
July 20, 2024