Capital markets experienced another wild ride in March. With the media coming up with excuses to explain the ongoing equity correction including US trade wars with China, the explanation boils down to two key factors: (1) valuations being elevated compared to historical norms, and (2) rapidly rising short-term interest rates.
What is happening with short-term interest rates? US consumer prices rose 2.4% in March year-over-year, the fastest pace in 12 months. Furthermore, tensions in the Middle-East will likely push gasoline prices to record levels this summer, thereby further driving inflation expectations higher. While inflation is still low compared to historical levels, the rising inflation expectations have pushed short-term interest rates up rapidly in just the past six months.
Beware the flattening yield curve. Referring to the chart below, the 2-Year US Treasury Rate has increased a full 1% since September 2017 to 2.29%. With the 10-Year US Treasury Rate sitting at 2.78%, the 10-year minus 2-year spread, sits at a meager 0.49%. This spread is typically referred to as the yield curve. When the spread approaches zero and begins to turn negative, short-term interest rates are higher than long-term rates. As a result, corporations slow investment as their cost of borrowing increases, US corporate earnings are negatively impacted for companies with floating-rate debt, and the US typically enters a recession. While it is still too early to call an imminent recession, if short-term interest rates continue to sprint higher and the yield curve inverts, the US could be facing a recession in late-2018/early-2019.
We have used the correction to add new positions. We have managed our two portfolios very conservatively over the past several months given our valuation concerns. With valuations improving slightly since the January highs (but still far from where we get very bullish), we have added new positions such as China Mobile (CHL), Novo Nordisk (NVO), United Therapeutics (UTHR) and Signet Jewelers (SIG). With the exception of SIG, the other three companies happen to be more defensive business models in the health care and telecom sectors.
An overview of the performance of our actively-managed products is as follows:
- The AFINA Optima10 was down 1.8% March. The Optima10 is now fully invested with a 5% cash weighting and a 3.5% dividend yield. Notably, Franklin Resources (BEN) will be paying a US$3.23 special dividend on April 12, 2018, however, the stock traded ex-dividend on March 28, 2018 and shaved 2.0% off of the March Optima10 performance figures. This difference will be reconciled when client accounts receive the special dividend payment tomorrow.
- The AFINA Affinity was down 1.8% in March. The Affinity now has a 36% cash weighting and a 2.2% dividend yield. Notably, Franklin Resources (BEN) will be paying a US$3.23 special dividend on April 12, 2018, however, the stock traded ex-dividend on March 28, 2018 and shaved 0.4% off of the March Affinity performance figures. This difference will be reconciled when client accounts receive the special dividend payment tomorrow.
As of March 31, 2018. All figures are net of fees and other expenses. Past performance is not indicative of future results. Refer to https://www.afinacapital.com/legal/ for full details and disclosures.
(1) The benchmark represents a 50% weighting of the S&P 500 Total Return Index in Canadian dollars and a 50% weighting of the S&P/TSX Composite Total Return Index in Canadian dollars.