Ask us Anything Answers: Part 3

Today’s “Answers” blog will feature questions that Craig Aucoin addressed. Craig is a Chartered Financial Analyst and has an educational background in business/economics – along with his professional experience in trading and (of course) Portfolio Management. The questions he addresses below were more suitable for his level of expertise. Lets get at it!

Lower risk stocks

A popular theme this time around revolved around safe alternatives within the equity space. This does seem to happen during volatile markets! Specifically, Des asked about pipelines, Sonny asked about dividend payers like financials, utilities and REITS, as did Daddyo.

Craig notes that if you plan to “Buy & Hold”,  you want the company to have a long-term track record that you can be confident in. Pipelines are often dividend paying names that are capital intensive. Debt is a big part of their capital structure. That structure needs to be examined in this environment of higher rates. How vulnerable is the company and its profits if rates remain high?

Insofar as “safe” sectors, we need to understand that in a bear market environment – all stocks will be vulnerable. To be contrarian in this environment or any other time, is crucial. You want to buy depressed sectors at the right price, not just because it is depressed. Catching a falling knife is not the best way to do things in a higher risk environment. Sure – you may eventually be right, but better to get as close to the turn-up as possible. This implies that with depressed stocks that are cheap from a fundamental basis – base breakouts are a better way to buy than to buy while they are still in downtrends.

Daddyo specifically asked about REIT’s. Craig feels that some REITS, especially commercial, may have more pain before they get better. As rental office space struggles -and significant maturities are coming up for the sector – investors need to do their homework. See Keith’s interview with Bruce Joseph for a look at Canadian real estate – here.

On the plus side…Opportunities will present themselves in 2023 as greater clarity arises concerning interest rates. Keep in mind that many of these “sate” sectors  use significant debt as part of their capital structure. Their profitability depends to a large degree on the cost of that debt. We prefer to use a technical model to spot rotations into attractive sectors as opposed to thematic sector selection.

Bank defaults in Canada

Bump asks how a failure would affect an investors account held in an online brokerage owned by a Canadian bank.

Craig notes  that your investment brokerage account assets are protected by the Canadian Investor Protection Fund up to $1,000,000 per account. You might have multiple accounts that may qualify for more protection. More info can be seen here.

ValueTrend, through our custodian RJI, is protected under the same insurance.

On the same note, Ron asks about the safety of US banks. Craig replies: There is a great deal of uncertainty about the exposure that bank assets have to interest rates. The most recent financial crisis was 2008-09 in which it was largely a credit event. Markets seem to be trying to discount/ price  an environment that is not overly susceptible to multiple bank failures. The morning news is built to heighten the drama. Having said that, as noted in Keith’s recent blog, its the regional banks that are most susceptible to being caught without a bathing suit on when their tide goes out.

Options

Brian asks if we use options in our platforms. He wants to know if we think option strategies are good for retail investors, particularly covered call writing.

Craig replies: We do not use options as part of our equity strategy. Options can be useful tools to protect investors. As a retail investor there is a cost. Like insurance, you can have too much – which in turn reduces profitability. So, if you decide to buy puts, for example, do the math and probability analysis for the timeframe you structure the trade. It might not work out to be as favorable as imagined.

Covered calls can be appropriate and add return in an environment that is contained, range bound. Typically, its a less optimal strategy for retail investors in a trending stock, given the potential for being exercised. While we cannot advise you if an option strategy is appropriate for you, it is worthwhile to educate yourself on the subject to determine if options might be suitable for your needs. Google the term “understanding options” or “option trading for beginners” to explore this subject.

Currency hedging

Marc asks if its a good idea to hedge currency for his USD stocks.

First, Keith’s blog and video library has lots of input on the C$/USD trends. In fact, our recent Answers #1 blog addressed currencies. We recommend you do a search in the search engines of ValueTrend’s blog and video pages on the subject. Understand: Currency risk is obviously real, but, barring massive currency moves, the impact can be minimal compared to the overall gain of the stock itself. As part of the decision to enter a trade, the currency should be part of the analysis, and the cost of hedging, if you decide to do so. If the move in the currency vs the C$ is expected to be significant, it would be worthwhile to hedge. A tool you may consider for USD hedging, should you determine it is necessary, is an ETF that hedges currency risk. Example – Horizons DLR.

Flow through shares

Mike asks if there any worthwhile flow through share investments that have minimal risk of loss of principal.  Are they found only on oil patch exploration. gold prospects?

Craig’s response: First- yes, flow through shares are typically resource based. But here’s the most important part of your question answered: The question regarding “minimal risk of loss of principal” is a loaded one! In a nutshell…There is a high likelihood of losing capital with flow-through shares! They are usually very illiquid, and can be tied up for several years. The real benefit is the tax benefit. The challenge in resource sector is the capital intensity and time to prove the asset is viable. This can be significant – and should be considered when comparing buying a flow through share issue to alternative investments.

ValueTrend investing protocol

Chang wanted to know how ValueTrend invests its client’s money. Are we value investor or Growth investors? How do you make your choice of stocks to invest in? He also asks about our fundamental analysis priorities.

Craig’s response: We don’t really classify our stock picking process as “growth” or “value”. We can sometimes be considered value investors and sometimes growth investors.  We are not restricted by those labels. Its probably best to call our style “Growth at a Reasonable Price” (GARP).

Our process focuses on both technical and fundamental factors. It is a fusion that begins with the technical selection for stock specific investments. We then look at the underlying fundamentals. This is the opposite approach  to traditional investment firms – who typically prioritize fundamentals with a lesser emphasis on technical trend analysis. Both disciplines  must agree in order to make a stock selection.

Finally: The most important fundamental factors are strong management team, recognized potential catalyst(s), and revenue growth transparency.

Andy asked if we have a basic fundamental checklist that a retail investor might use. Craig notes: A Fundamental “checklist” cannot be used in a silo/ isolation. The context of the numbers he looks at is very important. Historic relationships, forward projects, that kind of thing. Management communication and track record is also very important, for both value and growth companies. Nothing makes a stock fall more than a dishonest or inconsistent management team.

As an aside, the Online Course outlines our allocation and Technical Analysis rules for further insights on how we do things. This course does offer some ideas for investors who desire a source for external fundamental analysis of stocks – including Stock Rover, Motley Fool, Valueline and others.

Democrats vs Republicans

Michael wanted to know if the outcome of the next US election might influence stock performance.

Craig notes: According to data compiled by Morningstar/ Ibbotson Associate- Since 1928 the year a Republican was elected US President average returns of S&P500 were 15.3%. This compares to average returns of 7.6% when a Democrat was elected. While it should be cautioned this is a historical average, it does give some insight into what we may expect. It is typical for Republican to be more business friendly less tax, more fiscally restrained. Democrats/ Liberals typically have propensity to spend & tax – a tendency that has been emphasized more in recent years.

High yield bonds

Tamar wanted to know what the high yield spread is, and how to play it. Tamar was also curious as to what the term “bps” means in that venue.

To start, “bps” stands for Basis points, or measurement of yield. So, 100 bps means 1%. 10 basis points are 0.10%. If rates rise by 2o bps, this means they went up 0.20%. The spread refers to the extra yield on a corporate or high yield bond, measured in bps, vs a treasury bond. Longtermtrends.com has interactive charts on high yield spreads here. You’ll note the spikes in spread, indicating risk premiums on low grade bonds, tend to peak near recession bottoms.

A positive spread is compensation for taking extra risk. In recessionary environment, these issuers (as a group) have greater difficulty making payments. Obviously, this is where credit quality studies come in handy. Making 500 bps (5%) more than a US treasury sounds great, until they default!!! Then watch what happens to your bond! It ain’t pretty.