David's Weekly Dec 9, 2022

Plan – Don’t Predict

In this week’s letter

·????????The Latest in Ukraine: A cheeky move by Ukraine and no signs of a letup this winter General Comments on the Markets – Let’s Just Try to Keep Some Balance Here

·????????From the Bulls: Is the job market really that tight, Linkedin thinks not.

·????????The (Stock Market) Bears:?One angle that shows why stocks might be more attractive than bonds right now

·????????RBC DS Portfolio Advisory Group – Global Insight Weekly

The Latest in Ukraine: A cheeky move by Ukraine and no signs of a letup this winter

The thing about fighting a war of survival is that those on the ground fighting for their lives are naturally far more motivated than those trying to take the lives of others.?The latter group just doesn’t have as much skin in the game.?Without drawing readers into the flashpoint of Middle Eastern conflicts, it is an interesting historical parallel to reflect on Golda Meir’s mention of her country’s secret weapon during the existential Yom Kippur war: “we have nowhere else to go.”?And so it is with the Ukrainians.

The longer this war goes on, the more it becomes normalized, even while the Russian forces continually bombard civilians simply trying to survive, while Ukraine focuses its energies on fighting military targets, oftentimes with some surprising ingenuity.

Indigenous Ukrainian unmanned sea vehicles

While the Americans have been reticent to provide Ukraine with weapons systems that can hit targets within Russia proper, Ukrainian engineers managed to refashion two soviet-era unmanned aerial surveillance vehicles with some explosives and sent them hundreds of kilometers into Russia. The latter strikes weren't far from Moscow. The first strike hit some of the long-range bombers being used to carry out the well-publicized attacks on Ukrainian infrastructure, and the second lit up a fuel depot.?Neither of these attacks will change the course of the war but they do show that necessity is the mother of invention.

Once, again, Vladimir Putin is raising the threat of nuclear war, as he does every few weeks, and, while being low on missile stocks, Russia has begun to use 1980s-generation nuclear-capable missiles in attacks, having removed the warhead and fired these off with no explosives.?Is this a message from Putin or is it simply some kind of pragmatism??Perhaps it’s both.

Belorussia could potentially open a new front as it announces exercises along the border with Ukraine with the Ukrainians responding by constructing protective lines along their side of the border.?Analysts we read are doubtful this front will open, but those analysts can’t predict the future.

It appears that the attackers and defenders in this war are reaching for their end goals with no compromise in sight.?Putin has messaged his country that the “special military operation” will continue for a while on the Ukrainian side there is no sign of capitulation. In fact, evidence is clearly the opposite of capitulation from the continued string of successes on the ground by Ukraine.?All bets are off on how this ends but signs are that it will continue for some time.?

From the Bulls: Is the job market really that tight? Linkedin thinks not.

We’re not sure when Linkedin jumped into the financial forecasting game, but considering they do track job openings and there are nearly 900 million members in 200 countries, perhaps they do know something.?Over the last few weeks, we’ve focused on the job market as a source of inflation, namely, wage inflation. When it’s tougher to find labour in an overheated economy, competitive hiring drives up wages.?And, a standard measure of that labour market tightness is the ratio of job openings to unemployment.?A higher ratio means a tighter market which leads to higher inflation which leads to higher interest rates from the Fed.?In the figure below, the conventional ratio is shown in green while Linkedin’s own measure is in blue.?Note that Linkedin’s ratio is much lower, hence, their analysis is that the market is not as tight.?A looser job market could lead to lower inflation which could lead to lower rates, sooner. Lower rates are good for the market.?And, that’s one for the bulls.

Two Views of Labour Market Tightness

The (Stock Market) Bears:?One angle that shows why stocks might be more attractive than bonds right now

The process of market valuation can appear overly complex. Sometimes it’s sufficient to think of things in simpler terms.?One of the best “sanity checks” a trader can use is very basic.?Before adding a stock to a portfolio, it’s always good to ask, “how far have we come?”?That is, how big a move have we already seen??Usually, if there’s an outsize move, such as the enormous rally during COVID when the NASDAQ technology index literally doubled, the market will inevitably blow off some steam.?These enormous rallies are usually accompanied by some kind of mania which, in the case of the NASDAQ, was driven in part by the feeling that we were living in a new, delivery-anything-and-everything-to-my-door (read AMZN), kind of world.?As always, reality eventually sets in and the market adjusts to the realization that it's not as “different this time” as originally thought.

NASDAQ Composite

So, looking at today’s markets, what can we do to determine if it’s a good time to buy stocks?

How much does it pay to own stocks vs owning bonds?

The answer to the above is straightforward, if not obvious.?Stocks pay dividends.?Bonds pay interest.?If the dividends you receive to own stocks are higher than the interest payments you receive to own bonds, then, by the measure of cash flows, today’s bonds are a better bet, as we’ll show in the table below.

But first, keep in mind that in reality there is a bit more nuance to the comparison.?First, when we talk about dividends, we should be thinking more about how much the dividend payout actually beats inflation.?That is if we have 4% inflation and the dividend is 4%, your real return is zero.?Same thing for bonds.?Another nuance is that stocks have unlimited upside so some of the return could simply be capital gains.?While, with bonds, if you buy them at a discount – i.e. for less than the $100 face value – your upside is ultimately limited to $100. Finally, if you’re Canadian, the after-tax value of $1 of dividends is greater than the after-tax value of $1 of interest.?One more small detail, and that is, stocks tend to be much more volatile than bonds, and those ups and downs can be a negative for investors.

With all that in mind, the chart below shows the ratio of dividends to interest, or, the “yield ratio”, for equities vs investment-grade bonds. Without dipping into the details of the actual calculations, we can see that currently, stocks are relatively expensive compared to bonds.?So, why is this bearish for stocks??Because if stocks are expensive compared to bonds, people will sell their stocks (bearish move) and buy bonds.?And, that’s one for the bears.

Wrap

With that, we’ll wind up this week’s letter, as always, with RBC Dominion Securities’ Global Insight Weekly.?Enjoy.

By Portfolio Advisory Group

In this week's issue...

·????????The one big thing -?With a U.S. recession looming in the distance, what are the consequences for investors? Our 2023 Outlook examines the issues and opportunities facing markets and asset classes in 2023.

·????????Regional developments:?BoC hikes rates by 50 bps; Excess reserve balances within the U.S. banking system are dwindling; Expect 50 bps hikes from the BoE and ECB; China’s reopening moves boost market sentiment

Please take some time to review the Global Insight Weekly .

Feel free to contact me with any questions and/or to discuss investment ideas.

I appreciate the opportunity to serve you and look forward to continuing to help you accomplish your long-term financial goals.

Thanks for reading and have a great weekend,

David