Choose quality names in economic turbulence

Posted on: June 6, 2011 in: Canadian Equities, Economic Growth with 0 comments

iShares CDN S&P/TSX 60 ( Ticker: XIU )

Note: A version of this post is published each Saturday in the  National Post newspaper.

What a rough start to an otherwise beautiful summer. Markets around the world fell sharply on Wednesday on a torrent of weak economic data. But there are good reasons for equities to rise after this setback. For investors, a continued focus on ETFs holding quality names is essential.

Renewed fears of an economic slowdown triggered last Wednesday’s sell-off. New data showed US manufacturing did not grow as fast in May as it had in prior months. Housing data from the day before had showed US home prices were down 4% this year, bringing the average home value back to 2002 levels. The poor numbers pushed up US bond prices as investors looked for safety. Demand for 10 year bonds pushed their yields below the significant 3.00% level for the first time this year. The irony is that the US has hit its debt ceiling and the US Federal Reserve will end its bond purchases at June-end: both factors that should be pushing yields higher. All this, plus persistent unemployment, left Americans feeling glummer than they did in April.

And misery loves company. Europeans watch in fear as the SS Athena sinks slowly. A year since the first life rafts set out and the Greeks have done little to improve their finances. Now under duress, they are considering selling assets (Get your islands here!). In the meantime, the yields on Greek sovereign bonds hit 16.5%, the highest ever, while German bunds are at 3%. Turns out the cruise ship Athena was really a junk.

This turmoil has confirmed what our central banker, Mark Carney, said in his statement last week: that the economy is growing, in both Canada and globally, but the recovery is still fragile, especially in the US and the Euro-periphery, and that while food and gas prices have pushed up inflation, it should moderate from here. As a result, Mr. Carney left rates unchanged but said a rate hike would come as soon as possible. As I wrote last week, this wait-and-see policy is exactly what the US Fed has adopted.

Which brings us to the good news. Central bankers are worried and ready to do anything to avoid a repeat of 2008. They will keep rates low. They may even keep the stimulus tap open longer than they say they will. Both Mr. Carney and Ben Bernanke, the US’ central banker, have said they have no firm timeline for withdrawing stimulus funds. I don’t argue the merits of the policy. I simply accept it. Since the lows of March 2009, low interest rates and government stimulus have fed the rally in equities, commodities, even, some would say, the surge in merger activity. As long as money supply remains plentiful, it is better to be in equities.

The benign financial conditions bode well for equities. Yield spreads – the difference between short and long term interest rates – are wide. Typically, they narrow when financial stress is high. Corporate profits are strong, as the latest earnings showed. Corporate balance sheets are flush, as the boom in merger activity shows. Even US housing values are at or near their bottom as renting has  become costlier  than owning.

There are other positive signs. Commodity prices, victims of their own success, have fallen from their March highs as they suppressed economic growth. OPEC, for the first time since 2007, is considering boosting production to help ease prices. Good news for the US, China and India – all net importers – whose growth has suffered from $100+ crude.

In this investment environment, investors would do well to select ETFs of quality stocks of companies that can sustain some turbulence. For Canada, that means the S&P TSX 60 index of the 60 biggest companies. It avoids the smaller firms that make up a quarter (by weight) of the S&P TSX Composite. There are two TSX 60 ETFs to consider: 1) the iShares S&P TSX 60 ETF (XIU), the oldest, largest, most liquid ETF in Canada; and 2) the Horizons S&P/TSX 60 TR (HXT). HXT is much smaller and not as liquid as  XIU but has a couple of advantages: its annual MER, at 0.07% ($7 per $10k), is less than half of XIU’s; to defer taxes, rather than paying out, it reinvests its dividend.

archerETF Metrix XIU
Category Cdn Large Cap
Benchmark S&P TSX 60
Total Holdings 60
52 Week High $20.60
Recent Price $19.90
52 Week Low $16.13
Avg Daily Volume 8.29 Million Shrs
Avg Daily Volume ($) $164.95 Million
Total Market Cap $11.07 Billion
ETF Annual Fee 0.17%
ETF Trading Currency CAD
ETF FX Exposure CAD
Annual Volatility 23.4%
Correlation to S&P 500 96.1%
Return to Risk Ratio 1.59
Use of Leverage No
Use of Futures No
6 month Return 4.69%
1 Year Return 15.54%
2 Year Return 26.61%
3 Year Return -5.32%
Dividend Yield (TTM) 2.22%

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© 2011 archerETF Portfolio Management is a division of Bellwether Investment Management, a discretionary portfolio manager registered with the Ontario Securities Commission. This report is provided for information only and does not constitute investment advice. While we believe the information to be accurate and timely, we make no claim or warranty to that effect. Please seek professional advice before making any investment decision. We may hold positions in any or all securities discussed in this report.

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