Timely portfolio advice
Every year I try to offer some timely investment advice. While I'm not one to make big, bold predictions, I (like most) have an opinion as to where good investment opportunities are to be found. This week, I'll summarize a detailed memo I sent to our firm's financial advisors recently on various investment segments. In brackets, next to each section title, is my general recommendation to have an over-, under-, or normal- weight position.
Corporate bonds (overweight)
A weak economy and corporate fraud have contributed to the battered stock market. But what has gone unnoticed by many investors is that corporate bonds have been beaten up even more - despite the fact that they're lower risk than stocks.
Bond market watchers keenly watch what's known as the "corporate spread", which is calculated as:
Yield on Corporate Bonds - Yield on Government Bonds.
I studied fifty years of this data in the U.S.; and the current "spread" is at the highest point that it's ever been during those fifty years. In Canada, the spread is at a ten-year high. Corporate bonds appear to offer better value than stocks at this point in time; so my recommendation is generally to resist the urge to go overboard on stocks. Rather, consider reorganizing your bond exposure to reduce government bond holdings, in favour of corporate issues.
If you want to invest in this segment via a mutual fund, the following are worth checking out: Fidelity American High Yield, GGOF High Yield Bond, Northwest Specialty High Yield (this one's more aggressive), PH&N High Yield, Standard Life Corporate High Yield A, Trimark Advantage Bond, and Trimark Global High Yield.
Overseas stocks (overweight)
If the valuation of U.S. and overseas stocks are compared, you will generally find that better opportunities exist outside of North America. Current valuation metrics, such as price-to-earnings (P/E) multiples, show overseas stocks trading at a 30% discount to North American stocks. Also, comparing each region's total stock market value in relation to gross domestic product shows overseas stocks as the better relative value.
Among overseas stock funds, my favourites include AGF International Stock, Brandes International Equity, Mawer World Investment, Templeton International Stock, and Trimark International Companies. Could the valuation gap persist or even grow? Sure, but I'm making a longer term bet that the market will eventually recognize the better opportunities available overseas.
Value stock pickers (overweight)
I've always had a bias in favour of equity managers that are highly sensitive to the price they pay for stocks. While nobody wants to pay too dearly for an investment, some are stingier than others. With general economic uncertainty, sluggish profit growth, and persistently high valuations on stock markets, a value style of selecting stocks simply provides less uncertainty.
While that's my opinion, not a fundamental law, it's also worth mentioning that nearly 100 years of stock market data backs up my assertion. My recommendation is to build portfolios around value-conscious stock pickers. Then, peripheral choices can fill in other specific or aggressive portfolio needs.
Small caps (normal weight)
I publicly stated that small caps were overvalued and poised to outperform in February 2000 (in a Globe and Mail article), in October 2001 , and in January 2002.
After my overweight recommendation and a period of strong outperformance by small cap funds, I'd now recommend taking some profit off the table and giving small cap funds a more normal weighting.
Hard assets (normal weight)
Hard assets include real estate, natural resources, and precious metals. While they've had a good run over the past couple of years, a longer-term holding (at a normal weighting) remains a sound idea. (See the January 2002 article above for fund recommendations.)
My advice is not a prediction for 2003, but rather an opinion that today is a good time to makes some portfolio shifts that I expect to be beneficial over a longer period of time. My advice is general and won't be suitable for everyone; which is why it's always a good idea to enlist the help of a good financial advisor.
I'd like to wish all readers a joyous holiday season and a new year filled with good health, happiness, and of course good stock market returns!
My next article will appear on January 12, when I'll provide a progress report on my recommendations from this past year.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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