Quarterly Market Commentary
as of March 31, 2021
What's happened since the last report?
The following commentary represents the opinions and analysis of Doug Nelson, President, Portfolio Manager, Nelson Portfolio Management Corp. as at July 1, 2020. Market and index returns noted below are based on the price changes for each quoted item for the period ending June 30th, 2020. Market Statistics: Source: https://YCharts.com
- Over the past 3 months (April 1, 2020 to June 30th, 2020) the Toronto Stock Exchange Composite Index (S&P / TSX Composite Index) increased in value by +15.97%. Of this amount, the bulk of the gain occurred during the month of April 2020 (+10.48%, where half of this gain occurred on April 6th, 2020). May saw returns of +2.79% while June saw returns of +2.12%.
- Since January 1, 2020, the TSX Composite Index is -9.07% while the New York Stock Exchange Composite Index in the U.S. is -14.51%. Europe / Asia is -12.34% so far this year while the Emerging Markets index is -7.1%. At this time, the NFC Tactical Asset Allocation Pool has a year to date return of -6.23%.
- The most interesting part of the returns so far this year has been the divergence between different sectors (see Table 1): In Canada we see that the Banks (-17.93% year to date), Energy (-47.3%) and Real Estate (-23.4%) have lagged the index considerably while Materials (is 13.79% which was driven by the +17.12% gain in Gold) and Technology (+15.28%) have seen significant gains.
- However, when you break this down even further; we see significant divergence between individual companies. For example, do you know the name of Canada’s largest company? If you guessed the Royal Bank, you would be incorrect. Canada’s largest company is now Ottawa based Shopify with a recent market value of $154 Billion compared with the Royal Bank of only $131 Billion, the TD Bank at $109 Billion, CN Rail at $85 Billion. Then we see firms like BCE at only $51 Billion.
- Shopify is part of the new digital economy, where their proprietary e-commerce platform helps businesses sell their goods on-line. In an on-line Covid 19 world, this is where some people have been investing their money and the stock price has risen considerably. Over the past 6 months the stock price is up by 150% and over the past 12 months the stock price is up by 227%.
- Shopify currently represents approximately 6% to 7% of the Toronto Stock Exchange Composite Index
- When you take this into consideration, it appears to me that the gains in Shopify over the past 6 months has added an additional +3.7% gain to the overall Toronto Stock Exchange index. This means that without these significant gains, the Toronto Stock Exchange Composite index (TSX) would have seen a year to date return closer to -12.8% (instead of the actual return of -9.07%).
- Over the past 12 months the TSX generated a return of -5.29%. When you subtract out the 227% gain in Shopify, it appears to me that the adjusted return would have been closer to -9.6%. This is also more in alignment with the 12 month returns we see in the New York Stock Exchange Composite Index (-8.86%), Europe / Asia (-7.39%) and the Emerging Markets (-3.83%). By comparison, the one-year return for the NFC Tactical Asset Allocation Pool was only -2.85%.
Table 1: Year to Date Returns of Various Canadian and U.S. Sectors. Source: YCharts.
Let’s take a closer look at three different Canadian companies: Shopify, the Royal Bank and Telus. For each we are going to look at a graph that shows both their total sales revenue and their stock price on the following pages.
Chart 1: Telus Communications: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- The purple line is the percent change in annual revenue. We see that over the past 3 years revenue has increased by 14.0%. This is good!
- The orange line is the percent change in the stock price.
- You can see over time that as the revenue increases, so does the stock price.
- At this time the stock price is well below the revenue line, which may suggest that the stock price has some catching up to do in the months ahead.
Chart 2: The Royal Bank: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- The purple line is the percent change in annual revenue. We see that over the past 3 years revenue has increased by 16.65%. This is good!
- The orange line is the percent change in the stock price.
- You can see over time that as the revenue increases, so does the stock price.
- At this time the stock price is well below the revenue line, which may also suggest that the stock price has some catching up to do in the months ahead.
Chart 3: Shopify: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- The purple line is the percent change in annual revenue. We see that over the past 3 years revenue has increased by 239%. This is really good! This is a great Canadian success story!
- The orange line is the percent change in the stock price.
- You can a similar relationship between the growth in revenue and the growth in the stock price up until these past three to six months.
- The stock price is well above the revenue line, which may also suggest that the stock price has gotten ahead of itself and it may need to correct at some point in time.
- The stock price may need to decline by 30% to 50% so as to be back in alignment with its growth in revenues, which goes to my point about some of the significant divergencies we have seen so far this year: if the share price of Shopify did not increase so much, it would not be Canada’s largest company and the TSX index would have a lower return than what it is showing at this time.
Why do I belabor this point? I point this out for three reasons:
- To put the returns of the NFC Tactical Asset Allocation Pool into some context, we like to measure against the TSX index. When we measure the year to date return of the pool at -6.23% and compare it to the TSX index at -9.07%, you and I would have expected the pool to have performed better relative to this index for this period of time. Since it did not, I looked deeper and we can now all see the Shopify effect. If Shopify did not grow to be such a dominant holding in the index, then the TSX would have seen a year to date return closer to -12.8%, which would be a far more attractive comparison vs. the NFC Tactical Asset Allocation Pool return at -6.23%. Over the past 12 months the TSX index return may have been closer to -9.6% vs. the NFC Tactical Pool return of -2.85%.
- Shopify is now a highly influential component of the Toronto Stock Exchange index. In the same way in which it helped to move the market index higher, it can also have the opposite effect if it started to decline. If Shopify declined by 33%, this would add an additional -2% to the overall index return. If Shopify declined by 50%, this would add an additional -3% to the overall index return.
- This is a good example of the disconnect we seem to have between aspects of the “stock market” vs. the “real economy”. Some areas of the stock market seem to be getting ahead of itself. We would love to own Shopify, but our preference is to buy this at a much lower price than today.
Now let’s look at a few other companies, such as Microsoft, Apple, Amazon and Google. These are also very large components of the Nasdaq 100 Index (the 100 largest companies on the Nasdaq Index). These four companies represent 40% of the value of the top 100 companies.
Chart 4: Microsoft: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- Over the past 3 years, revenue has increased by 43.6% while the stock price has gained by 196%.
Chart 5: Apple: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- Over the past three years, revenue at Apple has increased by 19% while the stock price has risen by 152%.
Chart 6: Amazon: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- Over the past 3 years, revenue at Amazon has increased by 97% while the stock price has only recently deviated from this trend showing a gain of 197%.
Chart 7: Google: The Last Three Years (July 1, 2017 to June 30th, 2020). Source: YCharts.
- Yet with Google we see something very different. Over the past three years revenue has increased by 68% while the stock price is up by only 55%. Does this suggest a further increase in the stock price of this company?
- There is no doubt that the technology sector has led the stock market much higher over not only these past few months but also over the past several years.
- In the last commentary I mentioned that the technology sector did not drop as much as the market overall while it has also rebounded much higher than the overall market over the past three months.
- One would expect that these very large companies, when they do correct, should correct as much or more than the market overall. Yet, these companies are also ecosystems until themselves, with interests in a wide range of areas that generate revenue in a great number of complementary ways. Yes, these companies are ecosystems unto themselves, which would suggest that they can continue to lead the markets higher over the coming years.
- However, with great power also comes great responsibility. Just as much as these companies may continue to lead markets higher, they will only continue to do so until such time as they no longer do so, which means that we need to manage risks by not being too over concentrated in these holdings.
- Yet, by not being too overconcentrated in these holdings also means that measuring returns against traditional market indexes (like the TSX Composite Index and the S&P 500 Index in the U.S.) is getting harder and harder to do. These indexes are being dominated increasingly so by these technology names, but from a risk management perspective our preference is to not be as concentrated.
This is why we conclude today that the performance of the NFC Tactical Asset Allocation Pool has been very good, but in a world with this increasing dominance by a handful of names, measuring performance against the traditional indexes doesn’t come without some further explanation.
- From January 1, 2020 through to June 30th, 2020, the NFC Tactical Asset Allocation Pool has declined by -6.32% (the green line below) vs. the S&P / TSX Composite Index showing a year to date decline of -9.07%.
- From April 30th, 2020 through to June 30th, 2020 (the past 60 days), the Tactical Pool has gained in value by 2.20% while the TSX Composite Index has gained in value by only 1.89%.
- Over the past 12 months, from July 1, 2019 through to June 30th, 2020, the Tactical Pool has declined by -2.85% vs. the TSX showing a 12 month decline of -5.29%, the New York Stock Exchange composite index at -8.86% and the Europe / Asia (EFA) index at -7.39%.
Chart 8: NFC Tactical Asset Allocation Pool Performance (Green) vs. TSX Composite Price Index: January 1, 2020 to June 30th, 2020. Source: YCharts. Croesus Software. Compiled by Doug Nelson.
Over the past three months the asset mix of the Tactical Pool has become increasingly growth oriented as you can see from Table 2 below. However, over the past month we have maintained our current allocation and expect that over the summer months we may tilt back towards defense if we some further economic weakness, recognizing that August and September can be the two weakest months of the year for the stock market.
Table 2: NFC Tactical Asset Allocation Pool: Asset Allocation Over the Last 3 Months:
Source: Croesus software.
What Have We Been Up to Over the Past Several Months?
The NFC Tactical Asset Allocation Pool is now broken down in the following categories:
- We have been continually taking advantage of opportunities to upgrade our defensive holdings. You can see that these holdings are now paying an annual yield that is close to 6.0% per year.
- The Canadian stocks section is a collection of 30 Canadian companies that are typically banks, insurance companies, utilities, and Canadian technology companies.
- The U.S. stocks section is a collection of 30 U.S. companies that are typically found in the Nasdaq 100, which has been the top performing index over the past 5 years. There are the core technology names such as Amazon, Google, Microsoft and Apple as well as significant exposure to Healthcare (e.g.: Johnson and Johnson), Consumer Staples (e.g.: Costco, PepsiCo) and the chip makers (e.g.: Nvidia, Intel, AMD).
- The Specialty Growth Sectors section has exposure to Canadian Energy (ZEO), Canadian Materials and Mining Companies (ZMT), Online Retail (IBUY), Online Payments (IPAY), Online Video Gaming Technology (GAMR), Cybersecurity (HACK), Cloud Technology Companies (SKYY), and Medical Companies (IHI) among others.
Our strategy going forward is to keep a bias towards all of the areas we are currently invested in, with an eye toward watching how the more expensive areas of the market hold up over the summer months. Over the past few weeks, we have added additional stop loss orders as automatic sell points in the event markets turn weaker.
At the client account level most clients will now have direct exposure to the Nasdaq 100 index, but through a currency hedged version from the Bank of Montreal ETF lineup (symbol: ZQQ). We do see a scenario whereby the U.S. dollar could continue to fall, which means than any investments held in U.S. dollars will lose value due to the changes in currency. This is something that we do wish to protect against.
Where Do We Go from Here?
At this time markets continue to trend higher. Being a U.S. election year, it is expected that there will be continued fiscal support from the U.S. government, which means that they will likely do everything possible to support the economy so as to hopefully win the election. This could mean that markets will always have some support and therefore may continue to move higher.
Both the Canadian and U.S. unemployment rates are in the 11% to 13% range today. Before the Covid-19 pandemic these figures were closer to 4.0% to 5.0%, which means that there are still a very large number of unemployed individuals, particularly in the service, travel, and leisure sectors. The Canadian government has extended many of the unemployment income insurance benefit programs, which suggests that they do not believe that the economy will be back to higher levels of employment any time soon.
With this uncertainty, many people believe that future earnings levels will definitely be lower and therefore, in time, the stock market will also retreat to lower levels at some point. This scenario seems very plausible, but the big question remains: Should this occur, to what extent will the core technology sectors see this same type of decline? If the correction in March 2020 is any indication, these sectors could decline much less than the overall market. Yet, if the economy does continue to open up and the travel and entertainment sectors begin to return to our previous normal, then perhaps it will be these same technology leaders that will begin to decline at that time. In other words, if we have good news in the economy, we might have bad news in the stock market, as the dominant companies discussed in this commentary see their values return to more reasonable levels.
Therefore, we take it a day and a week at a time. Mike W. continues to provide Lynda and I a day to day summary of the Tactical Pool performance vs. common market indexes. We are able to see the extent to which we capture the upside while also protecting against the downside. This is very helpful at this time when making investment decisions. Lynda also continues to do more research and tracking of certain areas of the Tactical Pool, such as the Private Lending Pools area. I continue to spend my time analyzing trends and looking for ways to continually increase returns without taking on additional risk.
As always, I very much appreciate the opportunity to be of service to you in this very important area. I appreciate the trust, confidence, and responsibility that you have placed in my team and I. As a result, I write these more detailed commentaries so that you can be aware of the types of things we are looking at, how we are evaluating our performance / decision making and how we are always looking for ways to improve what we do regardless of the market environment.
I would be delighted to meet with you at any time should you have any questions or concerns about your portfolio. I can also prepare for you at any time a more comprehensive analysis of your personal portfolio.
Thank you and I hope you and your family have a truly wonderful summer!
Welcome Michael Furtado to the Financial Planning Team! Mike joined the financial planning team of Nelson Financial Planning Corp. in late May. In his role as a Financial Planning Associate, Mike is working with Doug and Lynda in the creation and analysis of financial plans for our clients. This gives Lynda more time to focus on more detailed portfolio work as she works toward her full Portfolio Manager registration. Mike has over 10-years of experience in the banking sector, working with small business owners in a wide range of areas. Mike is also studying to complete his Certified Financial Planner designation over the next 12 months. Welcome Mike!
New Agreement With NBIN: Our new agreement with NBIN has taken effect. Due to our growth over these past several years, NBIN has reduced our trading costs by 20% to 40%. We also now have access to a high interest savings account option where no trading costs will be incurred when we buy or sell this investment. The deposit and withdrawal costs for the NFC Tactical Asset Allocation Pool will also decline from a flat fee of $25 per trade down to $15 per trade. These savings are very significant and expect them to add up over time.
Book Value vs. Market Value On Your National Bank statements: The book value information on your National Bank statement is not your net invested value. Rather, the book value is the total of your invested value minus withdrawals and plus any dividend income received. Thus, part of your investment return over time will show up as part of your book value. Therefore, please do not compare the book value and market value on your National Bank statements and believe that the difference is your investment return.
Discrepancies between the Nelson portfolio reports and the NBIN (National Bank Independent Network) monthly statements: We see that in some cases there are some small discrepancies between the total portfolio value seen on the Nelson statements and the NBIN monthly statements. In most situations these discrepancies are caused by the timing of when the NBIN statements are produced and when the data concerning the quarterly distribution for the NFC Tactical Asset Allocation Pool is provided to NBCN. This is a timing issue and not an error. Should you have any questions or concerns, or if you identify other discrepancies, please let us know immediately.
Paper vs. Secure E-Mail Link: It is NPMC’s preference to provide to you this quarterly portfolio package by e-mail. However, if you would like to receive this package in paper format, please let us know and we will accommodate your preference accordingly.
"IMPORTANT DISCLOSURES: The comments above are for information purposes only and do not constitute specific financial advice regarding your specific situation. Please consult a professional financial advisor who is familiar with your personal situation before acting on any information presented above. Every effort has been made to ensure this information is presented responsibly and accurately. However, important details may have been missed or these details may have changed since the publication of this note. All facts and opinions noted above must be reviewed to ensure their accuracy is still relevant based on today’s specific situation, whatever that may be. Nelson Financial Planning Corp is not responsible for any action you take regarding this information."