Still a good chance for equities as rates rise

Despite a slow rise in interest rates and continuing volatility in stock markets, there are still some good omens on the horizon for equities.

Despite a slow rise in interest rates and continuing volatility in stock markets, there are still some good omens on the horizon for equities.

“During the summer doldrums, (trading) volumes tend to be thin and moves tend to be exaggerated,” says Serge Pepin, Head of Investments at BMO Investments Inc. “Investors, however, should never lose sight of the yield curve, which is still relatively steep ­— a good indicator of economic growth. There are still good opportunities in Canada but you need to be choosey because it’s still a fickle market.”

“Don’t try to out-guess the market,” Pepin adds. “Stay diversified and sit tight if you hold quality. Anxiety will continue for a while but there is still a government backstop with the economic stimulus spending.”

The correction in the S&P 500 and the TSX from the highs of mid-April has provided the opportunity for investors to pick up stocks cheaper.

“Compared to an expectation of a 26-per-cent rise in earnings for S&P 500 companies at the end of March, analysts now are predicting a rise of 32 per cent for 2010,” says Patricia Lovett-Reid, Senior Vice President of TD Waterhouse.

Lovett Reid suggests investors stick with quality, large capitalization stocks.

“While small cap stocks may have outperformed their large cap counterparts in 2009, I expect investors to return to the safety of large cap dividend paying stocks in 2010,” she says.

“Avoid stocks with high debt-to-equity ratios as rising interest rates will mean rising debt servicing costs,” Lovett Reid recommends.

“On the other hand, companies which generate an operating cash surplus and have little or no debt will benefit from higher interest they earn on their cash surpluses. And look for companies which can pass on the increase in costs on its products to the end users, such as pharmaceuticals.”

There are several themes that investors should know about today.

One is Canada’s strength. “The TSX was the best performing G7 market in 2009,” Lovett Reid says.

“There is growing Asian demand for our agricultural products, crude oil and metals in the long term. We have a sound banking system and a stable and prudent government compared to other G7 countries.”

Another theme is to invest with the government. Stimulus spending will benefit the infrastructure sector for a while before austerity measures begin to kick in.

The BP oil spill has helped to raise attention about environmental sustainability. “Investors are increasingly supporting sustainability investing,” Lovett Reid says. “Consider investing in companies that focus on alternative energy, clean water and smart technologies that improve efficiency of limited natural resources.”

The aging baby boomers are expected to benefit pharmaceutical and orthopaedic implant companies and those that provide financial services and assisted living over the next several years.

“The key is to be able to identify the trends early and invest in the companies that will benefit from it and staying invested until the trend plays out,” says Lovett Reid.

Another good investment option in the current interest rate environment is precious metals, such as gold and silver, which can act as a hedge against inflation over the long term.

Real Return Bonds also can act as a hedge against any unexpected change in inflation. Unlike regular bonds, the principal and interest on RRBs are adjusted for inflation.

“Protect the downside risk in the portfolio through asset allocation in line with your risk tolerance, adequate diversification across countries, sectors and companies, and the use of strict stop loss rules,” Lovett Reid says.

Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors. He can be contacted at boggsyourmoney@rogers.com.