Can we talk about risk for a minute?

When you look at the tagline for ValueTrend, you might note that our motto is to “Limit your risk. Keep your money”. That’s been our philosophy for over 30 years. Its of particular importance when markets get overheated. I suspect we are in that “overheated” environment right now.

I’ve been addressing the subject of  structuring one’s portfolio towards the lower risk end of the curve over the past couple of months. For example: In my last blog, I noted that the pipelines might be a reasonable sector to examine to play the high dividend, lower beta (lower volatility) trade. In prior blogs, I noted that we at ValueTrend have not only raised some cash recently, but we have also been shifting into very selectively chosen staples, utilities, and other value sectors. This, as we continue to bring down the beta of our holdings. Why do I favor these sectors?

To answer that question – allow me to ask you a question first: Beyond the base/breakout chart formations that you know I am on the lookout for: What fundamental factors do all of these sectors have in common? Well, two things, actually. These are:

  1. Strong (not over leveraged) balance sheets and/or predictable cashflow
  2. Historically dependable dividends with growth.

A couple of charts supporting the argument to move into these sectors, if you feel, as I do, that markets may be subject to some volatility in the summer months.

Balance sheet strength- chart courtesy BearTraps

Balance sheet strength was hot pre COVID crash…but post-crash, the world fanatically bid up stocks with weak balance sheets. Stay-inside growth stocks prevailed, aided by next-to zero interest rates against their leveraged books. But that’s changing.

Despite US stock indices at all-time high levels, strong balance sheet equities have widely outperformed weak balance sheet equities over the past 5 weeks.  As inflationary pressures continue to build up and the threat of rising rates in the future increases, investors are going to shy away from levered / weak-balance sheet corporations WELL before the Fed brings up tapering. In a rising interest rate environment, investors may want to be overweight stocks with strong balance sheets.

 

Balance sheet strength inspires dividend growth

Strong balance sheets tend to inspire regular increases in shareholder rewards in mature companies – aka: dividend growth. The chart below, courtesy Franklin Templeton, shows us that such stocks are lower risk vs the SPX index and non-dividend paying (aka FAANG’S, growth, etc) stocks. True, indices leveraged to growth stocks and non-div. stocks (think NASDAQ) do end up making better returns when growth prevails. But…. its clear where you want to be when market risk is higher. Dividends matter when times get tough on the market.

 

Conclusion

Cash is king in a falling market. But markets don’t always decline in order to correct an overbought market. Sometimes they trade sideways for a while as the 200 day moving average catches up, bringing the market back in alignment. When the SPX hit its peak last week, I discussed how far above that indicator the market was (and is) – and why we should be concerned. If the market grinds sideways rather than sell off 10% or so as I suggested in that blog, we have a good case for staying largely invested – with a focus on dividend growth type stocks with great financials.

I will confess we are taking the middle-ground by raising some cash, while also swapping out some of our beta. We’re roughly 12% cash in our primary Equity model right now, with a little more in the Aggressive Strategy. Either way, by holding a good chunk of strong, low beta stocks, you will usually end up seeing less downside and more predictability in any kind of market volatility.

Globe & Mail interview with Keith Richards 

Here is an article in the Globe interviewing myself and 2 other Portfolio Managers to discuss value idea’s.

Value opportunities still exist in shift to stock-picker’s market – The Globe and Mail

 

 

11 Comments

  • I was wondering if you had any comments on the recent article on Sentiment Trader about technical analysis?

    I do read your blogs and find them very interesting.

    Thanks

    Reply
    • Mark–not sure which article you refer to–I do recall something about “technical analysis not working right now” – although I can’t recall if it was sentimentrader who said that–or if it was somewhere else–is that what you refer to?
      I found that very strange (again, not sure if it was them who wrote it). This is a flat assertion–its unusual to state that any discipline “isnt working”. The very concept of sentiment indicators is part of technical analysis–so their work isnt working? Perhaps not…for now–but thats why we have many tools to look at- TA has many, many many sides to it–as does fundamental analysis. Eg–fundamental people can be purely quant number people, or value people, or growth people, or GARP people, or qualitative (more product/management driven), or economist-like, etc
      Similarly TA can follow pure trends & MA driven, old fashioned chart formation people, be pure quants (tons of engineers are in the game), it can be program-trading driven, it can be EWT, Gann, momentum driven, breakout driven, sentiment driven, sector rotational, point & figure, candlestick, on and on and on…..
      So to imply that TA isnt working–this is like saying “my Ford car just got an oil leak so all cars of all types and makes are now getting an oil leak”.

      Reply
  • Hi Keith. Could you explain beta to me and where you obtain that value for a particular stock?
    Thanks

    Reply
    • We get our beta readings from Thomson Reuters (we have an institutional analysis pkg)—but I believe that the exchanges like TSX and NYSE, Nasdaq etc have them listed on the sites free.

      Beta is a relative value—so you could look at 3 year, 5 year, etc — its a measurement of deviation off of the given index over that period. So a 5 year beta is measuring how much off of the market the stock moved on a % relative basis over 5 years. The 3 year number might be different.
      A stock with beta 1.0 moves with the market (theoretically). A stock with a beta of 0.9 moves up or down about 10% less than the market. A stock with a beta of 1.1 would move up or down 10% more than the market. You can figure out your portfolio beta by weighting the % of each of your stocks, then take into consideration your cash (0.0 beta), and do the calculation. It is a moment in time–beta can change. But its a reasonable way to examine your risk or upside, all things being equal.
      Currently, the ValueTrend Equity Platform sits around 0.90–subject to change, of course.

      Reply
  • Keith, the C$ seasonal strength is April, and we have seen it strengthen more than most of us US $ investors thought it would. I have always enjoyed reading your analysis on the trend for the C$ vs the US $ any updates from your perspective ?

    Reply
  • Hi Keith,

    Canadian bank stocks have been on an incredible run for many months now. RY is about 38% above the 200 weekly MA, BMO roughly 45% extended from 200 MA weekly, etc.

    Do you see any pullback level that could be a potential entry long? Tough to chase now even if they just continue higher.

    Thanks for your thoughts,
    Lee

    Reply
  • I should note I realize you cannot comment on individual stocks so perhaps you can comment on the Canadian bank ETF.

    Thanks,
    Lee

    Reply
    • Well you cannot argue with all time new highs. Totally overbought, so expect a pullback but longer termed the chart is great.

      Reply
  • JUST BOUGHT THE (FXC) OR CANADIAN DOLLAR LATELY. ALSO LOOKING AT THE RATIO BETWEEN THE $USD AND $CDW ($USDCAD). IS THE COMMODITY STRENGHT SHORT TERM OVERBLOWN? WHAT ABOUT INFLATION ROLE IN THE MAKING?
    J.P.

    Reply
    • JP–you are correct in assessing that commodities are overblown–please see my recent video where I cover the major commodity charts. Not all are overdone. But–copper, metals, oil, lumber, are overbought- So we reduced (did not eliminate) our exposure. Long term we are bulls –there may be a neartermed pause on some of them over the summer

      Reply

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