“There’s been a flight to safety globally,” says John Rekenthaler, vice-president of research at Morningstar. And safety is not where it used to be, namely the United States.
“Over the last decade, Rekenthaler continues, the U.S. has been perceived as the safest of global markets, with an investor-friendly attitude and a favourable government; and so, stock prices demanded a premium with higher multiples and higher prices-to-book value. That perception seems to be reversing. Rates starting to rise and inflation moving in are hurting valuations. The U.S. is probably not so much ‘a great thing’ anymore, maybe is it too expensive.”
What’s the solution for investors? Where should they go? Is Canada a solution?
What About Canada?
Canada certainly seems like a haven for bruised investors, with a stock market P/E of 16, “which is a near 15-year low to the U.S.,” Rekenthaler recognizes.
However, following recent political events, such as the February “State of Emergency” rules, Canada could experience some headwind, warns Aidan Garrib, Head of global macro strategy and research, at Pavilion Global Markets. “I’ve been receiving emails from international clients asking me if Canada is a place where we want to be, he reports. Canada is seen as a country under the rule of law, but if even Canada can make you a non-financial entity at the stroke of a pen, that raises questions.”
Where Else to Invest?
Other developed markets present attractive valuations, Rekenthaler points out, notably Germany, Sweden and Australia – but not so much the UK. “If given a choice between U.S. and some of those countries, I would choose the second. They are fully developed markets, very stable politically, not corrupt and of capitalist tradition. They don’t have as much cutting-edge technology, they have more government regulation, higher taxes, but the gap between valuations there and in the U.S. appear too large right now.”
Garrib favours a few emerging markets. “Some have been quite resilient recently because they are fairly cheap, mostly commodity producing countries like South Africa, Peru, Chile and Brazil. But low valuations are certainly not a guarantee per se: “You can get Ukraine stocks at multiples of 2,” Rekenthaler reminds us. Garrib agrees: “Some markets should be fairly resilient, but nowhere will be really safe.”
What Sectors Make Sense?
Not many sectors receive both analysts’ accolades. Oil, they agree, offers a good refuge at this moment, its strong momentum initiated since last August helped along by the Ukrainian conflict. Of course, this industry is destined to go the way of the “buggy and whip”, Rekenthaler recalls, though that will certainly not happen in the next 20 years, but “oil looks very good right now”, he quickly adds.
Garrib finds that REITs, utilities and medical care constitute “good defensive areas and yield proxies,” he says. “If it becomes clear that the Federal Reserve is tightening, these pockets of resistance should hold up a little better.” Of course, they are not fail-safe bets.
Dividend paying stocks are another area the strategist favours, especially low-volatility dividend ETFs. “Those dividend yields become more attractive with bond yields that are presently lowering, Garrib says. As growth weakens, we will get lower 10-year bond yields and the yield curve will flatten, so we still see defensive values improve with dividends that will become more attractive.”
High tech is certainly not viewed as a defensive refuge at this moment, but unexpectedly Garrib singles it out as “the ultimate quality sector of proven compounders with ‘fortress’ balance sheets, tons of cash, lower debt, and greater immunity to inflation”. Investors should keep an eye open: “If the selloff progresses, you might see big tech rise again, he says. When growth deterioration becomes priced in, it will grow again.”
The trough for hi-tech “is hard to quantify”, Garrib recognizes, but it could be not that far away considering that the NASDAQ has traded in the 23-25 price/earnings range for the last five years. After peaking at 42 in January 2021, it slid back to its present zone around 27. “I can see it go down another 3 or 4 points,” he points out.
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