Entries from November 2020 ↓


DOUG  By Guest Blogger Doug Rowat

Growth versus value. It’s a rivalry as old as time. It’s the investment industry’s equivalent of the Red Sox versus Yankees.

And like the Red Sox versus Yankees, the Bronx-Bombing growth stocks over the long term have generally trounced the underdog value-stock Beantowners:

S&P 500 Growth Index (blue line) vs S&P 500 Value Index (white line – long term

Source: S&P, total return performance

Growth stocks have, in fact, returned an incredible 16% annually over the past decade versus 11% for value stocks. The value-stock rate of return is still impressive, but somehow it’s always overshadowed by its pinstriped growth-stock rivals. However, every once in a while, value stocks shrug off the demons of Bill Buckner, throw a bleeding Curt Schilling onto the mound and pull off an impressive victory. We may be witnessing such a value-stock win as we speak.

First off, what are value stocks? Value stocks, as the name implies, are underpriced equities, and because they’re underpriced, they’re often out of favour. Following the 2008-09 financial crisis, for instance, a lot of “value” could be found in US banking stocks or US homebuilder stocks. Similarly, the Covid-19 crisis, has created pockets of deep value as well.

An excellent example of a Covid-19 value stock would be Walt Disney, which is heavily weighted in most value indices and value ETFs. Fairly or not, Disney was punished at the outset of Covid because many of its businesses were seen as susceptible to lockdowns: theme parks, cruise ships and film production studios, for example. With sports also shuttered, ESPN, a smaller Disney enterprise, was also viewed as a liability. The end result was a more than 40% drop in its share price from its pre-Covid peak to its March 2020 lows.

Two main factors, however, have driven a recent rally in value stocks: 1) the perceived unsustainability of growth’s outperformance and 2) the positive developments surrounding vaccines.

First, growth’s overextension. Growth stocks usually experience free-reigning momentum and are allowed by investors to become expensive because investors are willing to pay extra for the growth potential. However, growth stocks are being viewed now as excessively overpriced. The chart below, for example, shows the rolling 12-month price return between the S&P 500 Growth and S&P 500 Value indices. As the chart indicates, growth stocks recently hit a relative performance extreme. In fact, the highest in history, eclipsing the highs seen during the tech bubble of the late 1990s. Given the run in growth stocks, the compelling value, so to speak, that value stocks are offering hasn’t been lost on investors.

Growth’s relative performance extreme: the highest in history!

Source: CFRA

Secondly, vaccine news. Using Walt Disney again as an example, the emergence of effective treatments for Covid-19 from Moderna, Pfizer and AstraZeneca in just the past month has allowed investors to picture a more normalized world in 2021, one where consumers return to theme parks and cruise ships, for example. Whether this will play out as smoothly as investors hope is, of course, the risk, but for now, the vaccines offer the possibility of beaten-down value stocks returning to higher levels of profitability next year. As a result, value stocks have begun to more strongly outperform, with the outperformance coinciding almost exactly with the vaccine news:

S&P 500 Growth Index (blue line) vs S&P 500 Value Index (white line) – q-t-d

Source: S&P, total return performance

Whether the outperformance can continue remains to be seen, but as markets and economies emerge from a crisis is often when value stocks realize their best sustained outperformance. An overextended growth sector and vaccine developments are also likely to serve as additional catalysts for the value sector. Therefore, it’s worth having a portion of your portfolio in value stocks (within a well-diversified value ETF, of course).

As the market emerged from the financial crisis beginning in March 2009, value stocks outperformed growth stocks consistently over the next two years, and did particularly well during the first year of the market rally.

The same thing may happen as we emerge from the Covid crisis.

Growth is great, but not even the Yankees can win every year.


Finally, I came across this nifty chart recently from Invesco. You might hate Biden and his economic policies or you might have hated Trump and his economic policies back in 2016, but this chart shows why it’s important to never let your personal antipathy towards a politician or a political party interfere with your investment decisions.

Democrat or Republican, never bet against America:

Growth of $10,000 in the Dow Jones Industrial Index since 1896

Source: Invesco
Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.


Hang on

Three more sleeps till Chrystia rocks your world. On Monday the shiny new finance minister will give an update. Not a budget (like all the adult countries have received during the pandemic). Just a back-of-the-envelope kinda thing to keep tab of Justin’s spending (another $532 million on Friday for indigenous folks).

Remember the last deficit number? Right, $342 billion. The most ever by a margin of almost three hundred billion. (By the way, one billion is 1,000 times a million.) This blog asked its sketchy readers for estimates on what the latest shortfall would be, since there have been many, many spending announcements of late.

Over 300 of you responded. The reader who comes closest to the announced number on Monday will be granted a guest post here – and the freedom to embarrass yourself on the topic of your choosing. It will be an epic moment.

Meanwhile RBC is guesstimating the deficit will be $370 billion for the year. In 2021, even with the pandemic ending, the bank says Canada will almost double the worst-ever Conservative shortfall, with the Liberal red ink amounting to another $90 billion as more spending programs (child care, pharmacare, green infrastructure) click in. All this will push the accumulated national debt well over $1 trillion, becoming the momma of all problems down the road when interest rates snake higher. Yes, Millennials have no idea what lies ahead…

So, how do we afford this?

In the short term, the Bank of Canada prints the money, sends it to Trudeau and he spends it. This is backed by the issuance of government debt (bonds) which investors, mostly institutional, buy. The debt is considered ‘risk-free’ by financial markets, paying peanuts – currently just under half a per cent annually on five-year money. Over time this will change as the economy rebounds, inflation returns and investors demand more.

So the feds also need to raise more revenues to help cover spending. Promises made in the September Throne Speech alone (like looking after your kids and paying for your prescriptions) will cost between $19 billion and $44 billion a year. Extra. Forever. This stuff can’t happen without more taxes, since the bond-flogging thing will get extreme.

Warns the scary CD Howe Institute: “Taxpayers and policymakers should not underestimate the scale of tax increases needed if Ottawa increases spending as much as envisioned in the Speech from the Throne.” Its conclusion was that the only way to Hoover more billions from citizens without hurting the economy too much is through the GST. Yes, back up to 7%. So when added to the provincial sales tax, that means HST of 15% in Ontario and 17% in the Maritimes.

Meh. This would raise about $15 billion, not even enough to cover the latest Trudeau promises, let alone any Covid stuff (vaccinating everyone will cost $2 billion). So it’s likely there’ll be more changes coming in the Spring budget (not Monday’s update). A candidate for that is a higher capital gains inclusion rate.

Yeah, again. The anxiety over this ebbs and flows, but it looks increasingly like Mr. Socks will go postal on ‘the wealthy’ now that the virus has emboldened him to give silly speeches about a ‘great reset’ and a re-engineering of society. (Sheesh, we just want our shot…)

My pal, tax expert Jamie Golombek, points out that 90% of Canadians never report a capital gain. And of those who do, three-quarters of the total was declared by just 10% of that group, with incomes over a hundred grand. In fact 55% of all the taxable capital gains in Canada were reported by people earning in excess of $250,000. That’s only 160,000 folks – and they’re already in the 50%+ top tax bracket.

So, yup, this change would affect a relatively small number who already pay a disproportional amount, but it would affect them strongly. So it’s a good thing the tax system has little to do with fairness, and much more with punishment.

How would it work? Well, raising the inclusion rate to 75% (the direction we’re headed in) would mean three-quarters of a gain added to taxable income for a year, then subject to the marginal rate. Since the most affected people are in the 52% bracket, the capital gains tax goes up 50%.

So what, the masses cry? Should we shed tears for the 1%ers?

Nope. But higher taxes on the money people make from risking their capital means they may risk it less. That hurts expanding companies, new start-ups, financial markets, commercial real estate and ultimately pension funds, while it encourages investors to hang on to gains instead of selling assets and triggering tax. The move would also make it wise for people to focus on keeping assets inside RRSPs and especially TFSAs, where gains remain tax-free.

Well, whatever happens, something will happen. Current spending is unsustainable. Yet the prime minister wants to spend more. Since over 40% of voters pay no net tax with the burden heaped atop the shoulders of a few, you can smell what’s coming. Chrystia wrote a landmark book on rich people, “and the fall of everyone else.” In her world, there would be no powerful wealthy folks. Just powerful political ones. And she plans on succeeding Trudeau.