Making sense of the markets this week: November 14

Each week, Cut the Crap Investing founder Dale Roberts shares financial headlines and offers context for Canadian investors.

Cyclical stocks may be ready for liftoff 

Cyclical stocks are priced similarly to the 1960s, early 1980s, early 1990s and early 2000s, according to Jim Paulsen, strategist at Leuthold Group. Those were periods that signalled the beginning of major bull market runs. He adds a bit of hyperbole perhaps suggesting that cyclical stocks may turn manic. But who knows? Perhaps there is some opportunity in the suggestion. 

Now, what are cyclical stocks? Here is a very good post on The Motley Fool (an investment newsletter), breaking down the categories of cyclical and non-cyclical stocks

“A cyclical stock is one whose underlying business generally follows the economic cycle of expansion and recession. Cyclical businesses perform well during economic expansions but typically experience significantly declining sales and profits during recessions and other challenging economic times.”

The growth of a cyclical stock or cyclical sector depends on the business cycle. More specifically, these types of stocks need a robust and growing economy. Cyclical sectors include financials, industrials, consumer discretionary, energy, materials and commodities. That Motley Fool post does a good job of breaking down the sectors and it provides a few examples of sub-categories and stocks within those categories. 

This post from RBC breaks down the types of stocks that work well in different parts of recessions and recovery periods through a full economic cycle. 

Investing in cyclical stocks may carry more risk due to a dependence on continued robust economic growth. Rallies in cyclical stocks can be more short-lived and are prone to falter at the first hint of a recession or earnings slowdown. 

If one were to choose to add to (or overweight) cyclical stocks or sector funds, impeccable timing is required. You would have to strategize when you enter and exit. Of course, most investment commentators suggest that market timing is next to impossible. 

That said, patience might be the “cure” for timing on the “when to buy” side of the equation. You might be in early, and there may be many bumps along the road. You may have found some great long-term value, but you’ll have to wait it out. 

On valuation and from that Seeking Alpha post:

“With cyclicals underperforming since March of this year, when treasury yields hit their highs, ‘investors have the opportunity to buy cyclicals priced similarly to where they were priced, historically, in the midst of many post-war recessions,’ Paulsen adds.

“As this analysis demonstrates, the excessive cheapness of cyclical stocks, currently, may be the most compelling gauge of future performance.”

I suggest that the “when to sell” part is quite easy. If those market-beating returns do show up, sell in stages and perhaps the stock sale proceeds take you back to your stock-to-bond (risk level) allocation. You’d move the monies to bonds or other risk-off assets. Or perhaps your cyclical profits are moved to more defensive stock sectors. 

Traditional value investing will often involve buying into cyclical economic sectors. And given that the U.S. tech giants have powered the current stock market rally—and as we discussed again last week they are certainly expensive—investors and fund managers are looking for greater value and opportunity. 

But value investing is not exclusive to cyclicals. Often, you can find value in any sector on a stock-by-stock basis. From the healthcare sector, a very defensive and non-cyclical sector, I hold CVS Health Corporation (CVS). The forward P/E ratio is 11.67 compared to 21.3 for the S&P 500, according to Seeking Alpha. A lower P/E ratio means you’re buying a stock or fund with greater current earnings. I have no problem adding money to that stock and a few others that appear (to my eye anyways) to offer greater current earnings and solid long term growth prospects. 

You could also seek out a value fund or find that greater value in a dividend-focused fund. A U.S. investor might even look to “cheaper” Canadian markets or other international markets. 

Back to those U.S. cyclicals: The pandemic has distorted business cycles and sector behaviour and how we might categorize stocks. From this TD America post, Investing in Cyclical Stocks: Has the Pandemic Changed the Outlook? 

“‘Compared to the overall stock market, cyclicals are in a position similar to where they were at the start of several past major bull-market runs: the early 1960s, early 1980s, early 1990s, and early 2000s,’ he writes in a note. COVID-19 has thrown some of these strategies into confusion, partly because the cycles have become so hard to identify. In May and June 2021, it appeared that the United States was winning the war on the pandemic through vaccinations, and the economy was ready to enter a long recovery phase. Then by August it became clear the Delta variant could be a huge challenge to a complete reopening, and some investors returned to ‘growth’ sectors like technology that initially carried the market in the early days of the pandemic.”

And the market-leading technology companies may have nudged their way into that secular recovery space. Also from that TD piece: 

“‘As the economy shifted to being more services driven, a lot of services are enabled by technology,’” Cruz explained. ‘So, to perform well in an economy directed by the service sector, tech companies with solutions will be in a good spot to help a service-led business.’”

The pandemic is still the wild card of the deck. It’s shaped our behaviours. And perhaps we are changed forever because of it. And our world adjusts, so does our definition of certain sectors and they might not perform in certain economic conditions. It’s not a complete rewrite of sector performance, but it appears that some editing is required. 

More on the evolving sector theme, Goldmans Sachs has released a series of ETFs, including the future consumer, future healthcare, future real estate, future tech leaders, and a future planet ETF that invests in the drive for a greener planet. 

This might all be confusing to many investors, and couch potato investors might suggest the consideration is a complete waste of time. For them, it is. The couch potato portfolios hold all of the sectors and rebalance on schedule. 

Most Canadian self-directed investors, however, build their portfolios around baskets of individual stocks. For those investors, it’s important to have a look at the sector concentration to check if the portfolio has any portfolio. An early-accumulator might approach the sector and asset allocation with a different lens compared to a retiree or a nearly-there retiree. They may require a healthy dose of defensive stocks and funds. 

This sector evaluation may be a consideration for many investors who have a Canadian home bias—and who perhaps exaggerate the sector weightings even further when they pick individual stocks. As we know, Canadian retail investors love their dividend stocks and will be largely overweight in the areas of financials, telecoms, utilities and pipelines. They’re light on cyclicals and growth, and that might create opportunity costs—missing out on potential market gains. 

To wrap this section up: I suggest, if you manage your own portfolio, you believe we’re on the other side of the pandemic and we’re in a new growth stage that has legs, you might consider Paulsen’s above message. 

Elon Musk, the poll and the tax hit

Yes, Elon Musk, the CEO of Tesla, keeps finding new and interesting ways to make it on the pages of Making Sense of the Markets. He recently took to Twitter asking if he should sell 10% of his Tesla stock? He said he would abide by the decision of the Twitter gang. 

Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock.Do you support this?

— Elon Musk (@elonmusk) November 6, 2021

Musk was responding to the allegation that unrealized capital gains is a form of tax avoidance. 

“Yes,” I voted. 

Here’s some overview and commentary courtesy of Seeking Alpha:

“‘Much is made lately of unrealized gains being a means of tax avoidance,’ Musk wrote in the tweet, adding that he would “abide by the results of this poll, whichever way it goes.’”

What happened?

About 58% of 3.5 million voters backed the move, putting Musk on the hook to follow through on his pledge. However, many expressed concern that such a sale would hurt the stock, especially after a new high of $1,229.91 reached last week and a 43% surge in October 2021. Last month, Musk slammed a Democratic Party proposal to tax billionaires’ annual unrealized capital gains, saying, “eventually, they run out of other people’s money and then they come for you.”

The tax bite is considerable and likely felt, even by one of the richest persons on the planet. From that same Seeking Alpha post:

“Meanwhile, the current top tax rate on long-term capital gains is 23.8%, but Congress has also considered raising it (changes often take place immediately to prevent gamesmanship). Many have additionally pointed out that Musk would have needed to sell millions of shares this quarter due to a looming tax payment of around $15 billion. He was awarded TSLA options in 2012 as part of a compensation plan and CNBC noted this could have been the real reason for the sale.”

On Thursday, November 11, 2021, it was reported that Musk sold $5 billion of Tesla stock. 

The electric vehicle market continues to shock us. In last week’s post we noted the partnership of Amazon and Rivian Automotive (RIVN). Rivian went public this week (trading on stock markets) and it had a dazzling start. Initially priced at US$78, it quickly climbed well above $115. The company has a market cap of more than  US$100 billion. 

As a publicly-traded company, Rivian starts with a market cap that surpasses Ford ($77 billion) and General Motors ($86 billion). However, it’s still worth only a fraction of electric vehicle pioneer Tesla, which has a market cap of more than $1 trillion. 

Rivian has yet to produce a vehicle. You tell me if that makes any sense? 

The U.S. infrastructure bill paves the way to profits? 

After months of political wrangling, U.S. President Joe Biden and the Democratic Party were able to pass the massive stimulus package. 

From CNN

“After months of debate, Congress passed the historic infrastructure package late last week. Once signed into law, it will deliver $550 billion of new federal investments into America’s infrastructure over five years. Funding for highways and roads, bridges, rail, the power grid, water systems, airports, broadband and public transit will get a big boost.”

The total infrastructure package on the table measures at $1.2 trillion. There is also the $1.85 trillion Build Back Better Act. That could take weeks or months to pass

Also, there’s an ETF for most everything, including infrastructure. You’ll find a few more thematic ETFs in the newly-released ETF Finder tool on MoneySense. We might look to thematic sector exposure for the explore portion of our portfolio. 

From Kiplinger, there are three infrastructure ETFs to harness the spending boom. You might tilt your portfolio toward that financial gusher. From that post you’ll find U.S.-focused and global infrastructure offerings. Keep in mind that these are U.S. dollar ETFs. 

In Canada—and in Canadian dollars—you can look at the iShares Global Infrastructure ETF (CIF), BMO Global Infrastructure ETF (ZGI), Dynamic Active Global Infrastructure (DXN) or the AGFiQ Global Infrastructure ETF (QIF-NEO). 

On a grand scale, these massive investments should stimulate the U.S. economy. And what’s good for the U.S. can be good for Canada, given that the U.S. is our largest trading partner. They might need more of our oil, gas, metals and other materials. 

Is gold stuck between a rock and a hard place? 

Gold gets a bad rap. And it gets a bad rep at times for its imperfect record as a hedge against inflation. As this section here shows, a basket of commodities is the most reliable defense against inflation. But gold has shone in the past, especially during the stagflation period of the late ’70s and early ’80s. 

These days, with inflation fears hogging the headlines, you might think the price of gold would be moving to new highs. Russ Koesterich, portfolio manager at BlackRock (BLK), suggests that elevated inflation is not yet enough for gold

“Gold’s rising correlation with stocks might be forgiven if it were fulfilling its traditional role as an inflation hedge. But, while gold holds its own over the very long term, it is not a particularly reliable hedge outside of multi-decade horizons (see Chart 1). For most of the year gold has exhibited virtually no correlation with daily or weekly moves in long-term inflation expectations.”

Source: BlackRock 

Instead of gold, Koesterich suggests: 

“Instead, today’s best hedge is arguably one of the simplest: Cyclical equities able to maintain pricing power. While gold has not kept up with rising inflation expectations, many cyclical industries—including energy, materials and select consumer names—have.”

And you might take a shine to silver. As Koesterich, points out: 

“One other option for those investors who want to include physical stores of value: silver. Unlike gold, silver has significant industrial uses and has recently tended to co-move with near-term inflation expectations. While not a ‘silver bullet,’ silver can be part of the arsenal.”

For the advanced couch potato portfolios that are all-weather (all economic conditions) models I had suggested that you might look at the Purpose Real Asset ETF (PRA) for commodities and commodity stock exposure. Another way at it that includes silver is by way of the Horizons commodities ETFs. They allow for gold, silver, oil and natural gas exposure. 

Here’s a very relevant and recent article, thanks to Jonathan Chevreau: “Are energy stocks a good buy right now?

I still hold some gold ETFs (that hold physical gold on my behalf), as well as some gold stocks. 

I would place more trust in bitcoin, what I would call “modern gold.” Real gold” has become my hedge for bitcoin. 

This week delivered another inflation scare in the U.S. 

Source: S&P Global 

Gold and bitcoin responded in positive fashion to the inflation print. 

The gold price is up over 4.7% over the last week, and my gold stocks are up about 10% for the week. 

If that blue line on the above chart keeps moving upward, I’d guess gold has a good chance of following along. 

Thanks for reading. Keep in mind that this post offers ideas and observations for consideration. This is not to be read as investment advice.

Dale Roberts is a proponent of low-fee investing and he blogs at Find him on Twitter @67Dodge.

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