Stock returns are now “a race against time”. Plus, why isn’t anyone talking about this inflation-friendly bond ETF?

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Michael Wilson, Morgan Stanley’s U.S. equity strategist, sees equity returns for the rest of 2022 as a race against time. Simply put, the Federal Reserve must crush inflation before an economic slowdown forces corporate America to massively cut earnings forecasts.

Wilson identified three negative trends during the S&P 500 quarterly earnings season that suggest trouble ahead for growth and earnings. First, consumers pinched by inflation are moving down, shunning high-end restaurants in favor of cheaper quick-service restaurants.

Second, the home renovation trend is slowing in the United States, a sign that rising interest rates are threatening a housing industry that accounts for nearly 20% of gross domestic product. Black & Decker has already cut its full-year earnings forecast and Best Buy’s management has noted a slowdown in consumer electronics.

The third trend is that of inflated stocks. Walmart Inc. is the starkest example of consumer companies ordering inventory for an accelerating post-pandemic economy. Instead, a significant portion of these goods went unsold as consumer demand weakened.

These signs of slowing growth should be good for bond markets – lower growth expectations lead to lower bond yields and higher bond prices. Indeed, that was the case in July, with the iShares Core US Aggregate Bond ETF gaining 2.5%.

Shares also rebounded in July and Mr Wilson fears this may be premature. Falling bond yields imply that bond investors believe the Federal Reserve will get inflation under control, but “this may result in a higher than normal cost, potentially a recession as they tighten further, which may leave a very small window for actions to work”. before earnings surprise on the downside,” he wrote.

Morgan Stanley expects earnings forecast cuts to intensify in September and October this year as third-quarter results disappoint (thanks to weaker economic growth) and estimates for the full year can no longer be supported.

Equity markets are currently balanced between hopes that the peak of inflationary pressure is behind us with a significant decline in consumer prices and fears that the monetary policy tightening by central banks used to tame inflation will causes a recession.

Tactically, I’ll be watching key recessionary indicators – like the slope of the US yield curve – while waiting for market volatility over the fall months to offer equities bargains.

A surge in bond yields on Friday and a drop in bond prices following much stronger-than-expected U.S. jobs data show how treacherous it can be to predict the way forward.

— Scott Barlow, Globe and Mail Market Strategist

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The summary

The opportunity for investors amid the latest superpowers scramble game

This week’s superpower scramble over Taiwan’s future illustrates why even peace-loving investors might consider adding defense stocks to their portfolios. The new confrontation between the United States and China follows the Russian invasion of Ukraine in February. This underscores the world’s disturbing inclination towards armed conflict – or, at least, heated confrontations and displays of military power. As long as this trend continues, Ian McGugan tells us that major US defense contractors such as Raytheon Technologies Corp. and Lockheed Martin Corp. offer an attractive counterbalance to the more volatile sectors of the economy.

How job postings can indicate when a stock is undervalued

Disturbing news is coming from some highly regarded companies such as Apple, Meta Platforms, Tesla and Shopify, to name a few. They have all recently reported a slowdown in hiring. That doesn’t bode well for their stock price, according to new research. As Dr. George Athanassakos tells us, the paper posits that one way to separate highly valued companies from overvalued companies is to look at the rate of job offers by companies.

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Ask Globe Investor

Question: I think the best time to buy bonds could still be in the future. However, I have been using short-term alternatives for some time and recently invested in iShares 0-5 Year TIPS Bond Index ETF (CAD-Hedged) (XSTH-T). This ETF focuses on short-term US TIPS (Treasury Inflation-Protected Securities). Its year-to-date distributions (which vary monthly) were $1.24 (about 3.3% for part of the year only). The MER is low at 0.16%. Sure, the market value has fallen by a fraction this year, but I think it offers the benefits of inflation protection (through increased/variable distributions) and short duration. Is it a good combination right now? Nothing is ever mentioned about this bond alternative. Why not?

Answer: This fund has been around for barely a year (it was launched on July 6, 2021). However, it has attracted considerable investor interest, with over $153 million in assets under management.

The face value and coupons of TIPS increase with inflation, so they offer some short-term protection. Despite this, the fund’s total return for the year (through July 28) is down slightly to minus 0.06%. It’s much better than most other bond ETFs, but it’s still a negative.

Monthly distributions are completely unpredictable and therefore useless in attempting to calculate the forward yield. The fund paid 6 cents per unit in March, 20.8 cents in April, 25.2 cents in May, then 41 cents in June. In July, it fell back to 15.5 cents. Who knows what August will bring?

This is a short-term bond fund, so gains or losses will never be dramatic. It’s a better choice right now than BlackRock iShares Core Canadian Short Term Bond Index ETF (XSB-T), which has lost 3.25% since the start of the year. But you better put the money in the iShares Premium Money Market ETF (CMR-T). That’s only a paltry 0.33% upside for the year, but at least it’s on the positive side of the ledger.

–Gordon Pope

What’s up in the coming days

Ian McGugan will attempt to make sense of the mixed and confusing signals from the economy and financial markets at the moment. Plus, we find out what David Barr of PenderFund Capital Management is doing in his portfolio.

Click here to view Globe Investor’s earnings and economic news calendar.

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Compiled by Globe Investor staff

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