enr market outlook november 2018 - garyscott.com · the 47 acwi component markets, two have already...

November 2018 ENR Market Outlook

Executive Summary:

• Both stocks and bonds posted heavy losses in a rough October. Triggered by several large-cap earnings

disappointments, big misses on some leading technology stock revenues, a surging USD and fears of additional

Federal Reserve tightening all contributed to spook investors in the worst month for global markets since May

2012;

• In October, the MSCI World Index suffered its worst monthly decline since May 2012, dropping 7.4% and marking

its first trailing 12-month loss since early 2016. The S&P 500 Index, the world’s leading stock-market until recently,

posted its worst monthly loss since September 2011, falling 6.9%. The MSCI Emerging Markets Index, which

peaked in late January, tumbled another 9% in October and is down 17.5% in 2018. From its peak, the MSCI EM

Index is now down more than 20% and comfortably in bear market territory;

• The MSCI ACWI (All Country World Index), which includes major and emerging market equities has broken down

with the cap-weighted index down 10% from its January high and the equal-weighted index off by 15%. Among

the 47 ACWI component markets, two have already dropped by more than 30% (China and Greece), eight by at

least 20%, 17 by more than 15%, and 30 by 10% or more, with the median market down by 12%. Close to half of

the markets have reached 12-month lows;

• It’s not just revenue disappointments irking stock investors. It goes much deeper. The trade war between the

United States and China is getting worse and could possibly last another year or more. There doesn’t seem to be

any initiative on either side to arbitrage differences or find common ground ahead of a G-20 gathering in Argentina

this month, including the United States and China. A new development this quarter is the number of U.S.

companies reporting trade tariffs; almost a third of constituent S&P 500 Index companies are reporting higher

input costs tied to rising raw materials and trade tariffs. Among them is farm manufacturing giant, Caterpillar

Corporation (NYSE-CAT);

• The Bloomberg-Barclays Aggregate Bond Index, including investment-grade bonds in mortgage agencies,

corporate debt and Treasury securities, declined 0.83% in October as a ‘flight-to-safety’ into fixed-income failed

to materialize. High-yield debt and other risky bonds also declined. The Bloomberg-Barclays Global Aggregate

Bond Index of sovereign countries, has declined 3.4% this year and on track for its third-worst year since its

inception in 1990;

• Increasingly, the post-1998 negative correlation relationship between equities and fixed-income markets is less

pronounced as several new variables quash a matrix that’s so important to traditional portfolios. Rising U.S. rates,

higher wages, declining foreign demand and a deluge of fresh government supply of Treasury securities to finance

bulging deficits this year have weighed on bond markets;

• Foreign buyers of U.S. Treasury bonds fell to 41% of outstanding Treasury debt – the lowest share in 15 years and

down from 50% as recently as 2013, according to U.S. Treasury;

• The U.S. government ran its largest budget deficit in six years in the fiscal year that ended in September. The

deficit totaled $779 billion, up 17% from $666 billion in fiscal 2017, according to the Treasury Department. The

White House and CBO both project deficits of $1 trillion in the current fiscal year;

• In September, U.S. wages increased 3.1% compared to 12-months earlier, according to the Labor Department.

That marked the biggest rise in nominal wages since 2009 and sparked concerns the Fed will have more

justification to hike lending rates in December;

ENR Asset Management Inc. • 1 Westmount Square, Suite 1400 • Westmount, Quebec • H3Z 2P9 Canada Phone 1-514-989-8027 • Fax 1-514-989-7060 • Toll free 1-877-989-8027 • www.enrassetmanagement.com

2 ENR Market Outlook

• China’s GDP slowed its lowest levels since 2008 in the third quarter (Q3). Chinese GDP expanded 6.5% in Q3 as a

global economic slowdown and U.S. tariffs continue to take a toll on the world’s second-largest economy. The

United States plans on raising tariff rates on $200 billion worth of Chinese goods to 25% next year from the current

10% and is threatening to impose tariffs on an additional $257 billion of Chinese products;

• Investors worldwide redeemed $36 billion from bond funds and bond ETFs in October, the largest withdrawals in

three years, according to EPFR Global. In the ETF sector, bond withdrawals totaled $1.57 billion last month – the

first net redemptions since December 2015. In 2017, bond funds and ETFs drew more than $600 billion of net

inflows;

• Even though emerging market stocks and bonds have tumbled this year, investors continue to channel positive

cumulative fund-flows. European equity funds and ETFs, however, rank as the worst sector as it pertains to money-

flows. According to EPFR, more than $50 billion has flowed out of European-focused stock funds since January;

• Commodities, almost impossible to predict, consolidated in October as the Reuters-CRB Index declined 2%.

Energy, the single largest constituent in all commodity benchmarks, swooned 14% in October to close at a seven-

month low of $63.14. U.S. oil prices have declined more steeply from October highs as stockpiles have climbed.

The Energy Information Administration reported U.S. crude-oil output reached a record 11.3 million barrels a day

in August; this month, we’ve upgraded the energy sector following a significant correction in October. See our

Commodities section this month on Royal Dutch Shell Class B ADR (NYSE-RDS.B);

• The Chinese yuan, a source of trade contention between the United States and China, hit its lowest level in ten

years on October 30. In late October, the central bank set the dollar’s reference rate at 6.957 yuan, putting the

Chinese unit at its lowest level since May 2008. China’s currency has been hit hard this year by trade tariffs, rising

capital outflows and a slowing economy. A continued decline in the yuan might push the United States to peg

China a currency manipulator in 2019. Last month, the U.S. avoided pegging China a foreign-exchange

manipulator;

• The American dollar surged in October, outpacing all currencies except the Japanese yen and Brazilian real; The

U.S. dollar’s share of global foreign-exchange reserves fell to 62.5% in the second quarter, its lowest level in five

years, according to the IMF;

• In our view, U.S. corporate earnings finally peaked in the third quarter. The nine-year secular bull market is

increasingly growing fragile this fall amid rising interest rates curtailing some liquidity in world markets, less central

bank monetary stimulus, a surging dollar and lower company revenues. U.S. corporate tax cuts enacted in

December 2017 have extended the economic cycle, but stimulus is fading, and investors should prepare for

challenging markets next year as the Fed seems determined to cool economic growth;

• For the first time since 2012, we have turned NEUTRAL on global equities and have downgraded our outlook for

stocks heading into 2019. In October, we reduced our stock market exposure for managed accounts and took

advantage of a late-month rally to unwind holdings;

• Low volatility, which remained historically calm from March 2016 to January 2018, has now formally ended in

favor of growing volatility as the post-2009 global economic recovery is threatened by a powerful combination of

factors, including rate hikes, fading tax stimulus, declining revenues, a strong USD and the consequences of trade

tariffs, gradually eroding corporate profit margins as we shortly commence 2019;

• Investors are advised to use seasonal strength starting in November to further reduce non-core stock market

holdings and other risky assets ahead of a bear market in 2019.



Global Equities

How to Conquer the Next Bear Market Using

Alternative Investments

Are you prepared for a significant stock market decline? Is your IRA or 401k braced for a bear market? More importantly,

are you planning on retiring over the next ten years and drawing income from your stock and bond portfolio? If you’re not

ready for a bear market or an economic recession, now is an opportune time to review your nest egg and reduce stock

market risk. The October sell-off was a wakeup call to this advisor. It portends to big trouble coming our way, probably in

2019.

The magnitude and severity of October’s global market swoon took many investors by surprise. Bull markets tend to make

investors ignorant, arrogant and complacent. Unrealized capital gains also give the individual a false sense of prosperity.

Nobody likes losses, realized or unrealized.

Corrections, of course, are part and parcel of investing in stocks and other asset classes. They’re a perfectly normal

function of the price process; any investment that goes straight up probably isn’t an investment, but a speculation. There’s

a big difference. One example that comes to mind is Bitcoin. Twelve months ago, the financial press couldn’t stop talking

about it after massive triple-digit gains. After a 65% crash this year, they’re done talking about Bitcoin.



In August, the United States officially recorded its longest equity bull market in history, surpassing the 1990s in duration

and the second most profitable bull market after the 1920s. Since its March 9, 2009 bear market low, the S&P 500 Index

has gained a cumulative 305%, including dividends. In fact, the United States ranks as one of the top-performing markets

over the past decade, handily outpacing major and developing markets. Since 2008, the S&P 500 Index has gained 10.74%

per annum compared to 6.33% for the MSCI World Index and 2.91% per annum for the MSCI Emerging Markets Index.

Only India and Norway come close to beating US. stocks over the same period.

Bull markets always come with expensive multiples. The cyclically adjusted price-to-earnings ratio popularized by Yale

University economist and Nobel Laureate, Robert Shiller, is 30.6 times historical earnings. That’s its highest level ever

outside of the dot-com bubble of the late 1990s when it reached 44.2 and even 27.5 in October 2007 – just ahead of the

financial crisis. Sure, corporate tax overhaul and a strong economy continue to power earnings, but for how long? And a

30.6 multiple is rich, and indicative of lower future stock market returns, according to Professor Shiller.

Stock market valuations aren’t the only indicator flashing a warning sign in late 2018. The percentage of U.S. household

financial assets (stocks, bonds and cash) that’s allocated to equities hit 56.3% this summer, more than ten percentage

points higher than its historical average of 45.3%, according to Ned Davis Research and the Fed. At the top of the bull

market in October 2007, it stood at 56.8%. Other important market indicators point to the highest risk for investors since

late 2007, including:

• Longest bull market in U.S. history has stretched valuations not only in stocks but also bonds, real estate, art, private equity and collectibles;

• Second-longest economic expansion since WW II; • Shiller P/E Ratio = 30.6x vs. median of 15.7x historically; • U.S. stock buybacks at record highs at $1 trillion dollars this year; exceed 2007 all-time high; • Record mergers and acquisitions volume at $3.2 trillion dollars; • Record low corporate and high-yield credit spreads; low default rate under 4% • Record U.S. corporate debt and emerging market corporate debt levels; • Consumer confidence at 18-year highs; • Record U.S. hedge fund leverage (prior to October); • Record NYSE margin debt (prior to October); • Record levels of student debt; • Record private equity valuations; • More ETFs than listed public companies (indexing mania) • Federal Reserve still raising interest rates; • Trade wars and risk of recession growing; • Cryptocurrencies, Cannabis and other late cycle ‘hype’ trends

How to Reduce Portfolio Risk

Since 1926, the average bear market in the United States has resulted in a 41% loss for stocks, according to First Trust Advisors LP and Morningstar. Considering the current economic expansion is now the second-longest in American history and the second most profitable bull market of all time, this is an ideal time to cut your portfolio risk, especially ahead of retirement over the next five-to-ten years. A bear market can do severe damage: a 25% loss to capital will subsequently require a 34% gain to break-even. Worse, a 50% market crash will require a subsequent 100% gain to recoup your loss. For most investors, losses of this magnitude are destabilizing, to say the least. And for most pensioners or future retirees, recovering from a double-digit bear market might not even be possible.



I’m not expecting another financial crisis like 2008, at least not now. The U.S. banking system is far more regulated, heavily liquid and bank balance-sheets are much less leveraged compared to late 2007. But European banking is a different story; some banks in the euro-zone remain under-capitalized, including possibly some of Germany’s largest banks and Landesbanks. Italy has ballooning NPLs (non-performing loans) in excess of EUR 260 billion, according to Intelligence on European Pensions and Institutional Investment.

Other sources of potential instability and contagion are growing, especially in China where a credit bubble continues to inflate and several other large emerging markets where a currency and debt crisis has surfaced since last summer. Also, the United Kingdom has yet to negotiate Brexit and the Italian populist government refuses to cut spending, putting more pressure on the world’s second most-indebted nation after Japan. Rising U.S. rates also pose a major risk to corporate and high-yield (aka junk bond) markets where record issuance since 2012 has resulted in a gigantic pile of outstanding debt. Higher interest rates make debt refinancing more expensive and can trigger a bond market dislocation.

The way I see it, stocks and high-yield bonds are risky. They’re both expensive, late-cycle assets and neither has suffered a correction greater than 20% since the summer and fall of 2011. That’s a long stretch without a market decline or dislocation.

Consider the following defensive portfolio hedges now. ENR has begun to liquidate non-core equity holdings since late October and will gradually build its hedging portfolio over the next several weeks and months. If stocks muster another big rally, which I expect, defensive investments will go ‘On Sale’ as the markets rejoice a rally. The S&P 500 Index has risen in the year after every midterm election since 1946, according to Strategas.

It’s important to note that just because you’re repositioning a portfolio for a bear market, doesn’t mean you have to sell everything and incur a hefty tax bill. Not at all!

You don’t necessarily have to sell stocks and realize capital gains taxes (if you’re invested in a taxable account). Instead, I would reduce your smallest percentage gainers and liquidate your losers to minimize your tax bill. And for the most part, you can continue to hold most of your stocks provided you apply several hedges to reduce portfolio risk. Hedges are securities that provide a negative correlation to stocks under most adverse market circumstances; they should be liquid, inexpensive and most of all, profitable when stocks swoon.



Question: What if I just invest 50% of my portfolio in Treasury bills and keep the remaining 50% of my portfolio invested in stocks? Won’t that suffice as a market shock-absorber?

Unfortunately, no. A portfolio holding 50% in stocks and 50% in T-bills is still exposed to market risk. If you’re 50% allocation to equities suffers a 25% hit, your portfolio will decline 12.5%, before interest earned from your T-bills. A 50% allocation to T-bills will barely earn you 100 basis points and leave your portfolio with approximately an 11% loss. You really need to be almost entirely out of the market to avoid losses in a bear market.

I have a better solution, if you want to remain partially invested in stocks.

My favorite portfolio hedges include an actively-managed short-selling exchange-traded-fund and a passive short-selling ETF; foreign currencies like the Japanese yen and Swiss franc; an inverse-index high-yield bond market ETF, gold bullion and high frequency trading firms. I also think options and futures exchanges are potentially profitable amid heightened volatility.

Inverse ETFs

If you own a portfolio of stocks totaling at least 60% of your total asset allocation, then consider placing 5%-10% in the AdvisorShares Ranger Equity Bear ETF (NYSE-HDGE). Co-managers John Del Vecchio and Brad Lamensdorf have run a short-dedicated hedge fund since 2007 and have years of experience in this skill-based discipline. They also worked for legendary bearish investor, David Tice, at Federated Prudent Bear Fund. A short-selling strategy is very risky and not a long-term investment. Short sellers specialize in identifying financially troubled or overvalued companies and betting against them by borrowing shares in anticipation of buying the stock back at a lower price following a significant price decline. Short-selling has been a disaster in this bull market amid skyrocketing stock prices.

The Ranger Equity Bear ETF or HDGE, which launched in January 2011, generally gains more than the inverse of the S&P 500 Index during market declines and holds up well versus its indexed peers when the market rallies. In five out of six down periods for the S&P 500 Index since 2011, the ETF beat the market’s inverse, sometimes by a wide margin. In the



last mini-bear market of 2011, HDGE gained 30% as the broader market plunged 20% over the same period. Over the last five years, the ETF has declined 12% per annum compared to a 13% gain for the S&P 500 Index.

I anticipate the Ranger Equity Bear ETF will post the greatest profits in the next bear market or recession. That’s because it provides the strongest source of negative correlation to stocks – exactly the asset you seek to cushion from severe losses. Again, this should not represent more than 10% of a diversified stock portfolio. Fund expenses are high at 2.92%.

I also like to mix HDGE with SH or the Pro Shares Short S&P 500 ETF (NYSE-SH). Charging a 0.89% total expense ratio, SH is a passively traded short-dedicated ETF betting against the American broader market. It uses no leverage. I think SH and HDGE used together as part of a broadly hedged allocation to offset market exposure is exactly what a stock-market investor needs heading into 2019. Combined, both ETFs can represent 10% to 15% of your portfolio, depending on your gross equity exposure.

Other Hedges

Foreign currencies harbor the second-highest degree of negative correlation to equities after inverse-index stock ETFs.

Currencies are an independent asset class and provide a good source of returns amid market mayhem. The Japanese yen and the Swiss franc (CHF) should represent at least 10% of your foreign currency hedges. Both units are the top ‘safe-haven’ currencies when markets collide. In the first quarter, the yen rallied 6% and the Swiss franc rose 1.6% as global equities stumbled. In the 2008 financial crisis, the yen surged 23% and the franc gained 6%. In October this year, the franc declined a hefty 3% but the yen rose a modest 0.65%. I’d also include the Norwegian krone (NOK). Though the NOK is heavily tied to the oil market because of its heavy energy exports, the currency is fundamentally sound. Norway harbors a trade and budget surplus and is home to the world’s largest sovereign wealth fund. The NOK declined 3.6% vs. the USD in October.

Betting against junk bonds or high-yield debt is another sound hedge in a late-cycle economy. Global corporate borrowing is now in a full-fledged ‘bubble,’ especially American, Chinese and Indian companies. Many companies worldwide have issued long-dated debt since 2012; in the United States, the size of the BBB-rated 10-year plus index has surged to $878 billion from $235 billion a decade ago, according to ICE Bank of America Merrill Lynch. U.S. companies have issued more than $1 trillion of bonds every year since 2009 and last year sold a record $1.7 trillion.

The danger point is a combination of wider credit spreads and a flatter credit curve, which would signal deeper concerns about company balance sheets.

The ProShares Short High Yield ETF (NYSE-SJB) is a strong proxy to ride the end of the high-yield bull market. Credit spreads, the difference between high quality Treasury securities and high-yield bonds, remain historically low ahead of a huge wave of corporate refinancing is coming due starting in 2019. SJB also logged a strong uptick in the February mini-crash before sliding lower. The Fund buys swaps (derivatives) based on the Markit iBoxx $ Liquid High Yield Index issued by Goldman Sachs, Citibank and Credit Suisse. Daily trading volume is good.

The way I see it, betting against high-yield debt will be extremely rewarding. A recent article by Steven Pearlstein in The Washington Post ominously titled, ‘Beware the Mother of all Credit Bubbles’ argues that corporations will lead the next meltdown. Pearlstein correctly observes that the previous credit bubble was inflated by ‘households using cheap debt to take cash out of their overvalued homes.’ This time, in his opinion, the epicenter of the coming debacle is ‘giant corporations using cheap debt – and a one-time tax windfall – to take cash from their balance sheets and sent it shareholders in the form of increased dividends and stock buybacks.



Another very profitable segment of portfolio risk reduction lies in High Frequency Trading firms (HFTs).

HFTs use computers and speedy connections to exchanges to buy and sell shares in fractions of a second. It’s a controversial business due to critics like Michael Lewis, who accused high-speed traders of exploiting ordinary investors in the 2014 book, ‘Flash Boys.’ Though it’s probably true that HFTs arbitrage securities to make quick profits, we like the business because it’s incredibly profitable amid high periods of volatility. Case in point: February 5 to 9, 2018. HFTs posted gains of 35% to 55% in just four days of trading that week as world markets plunged. Heavy trading volume and volatile markets are ideal for trading firms. HFTs use computers and speedy connections to exchanges to buy and sell shares in fractions of a second. The more volatility in world markets, the greater the profits. In 2017, HFTs’ revenue from U.S. stock trading was an estimated $850 million, down from $7.2 billion in 2009, according to Tabb Group.

Based in the United States, Virtu Financial (Nasdaq-VIRT) is a $3.9 billion market-cap trading company. As volatility plunged in late 2016 and hit a 25-year low in 2017, VIRT struggled as trading volumes dropped. But in the first quarter, the emergence of volatility helped to lift the share price more than 88%; however, as markets have subsequently rocketed higher, VIRT has shed 47% since last spring, offering a great entry point for new investors. The stock now yields a 4.17% annualized dividend. Virtu Financial is incredibly volatile and shouldn’t represent more than 2%-3% in a stock portfolio. The stock gained 16% in October.

Sporting a $12.6 billion-dollar market-cap, CBOE is one of the world's largest exchange holding companies, offering cutting-edge trading and investment solutions to investors around the world. It’s usually a bear market-killer, too.

CBOE offers trading across a diverse range of products in multiple asset classes and geographies, including options, futures, U.S. and European equities, exchange-traded products (ETPs), global foreign exchange and multi-asset volatility products. CBOE is also home to the widely-followed CBOE Volatility Index (VIX Index), the world's barometer for equity market volatility.

Since going public at $29/share in 2010, CBOE has gained more than 265%, including dividends. That’s impressive performance considering this period has corresponded with a period of low volatility as measured by the VIX Index. As stock raced to numerous highs in 2017 and earlier this year, the VIX plunged to its lowest level since inception in 1993.



But here’s why I like CBOE now. First, the stock recently suffered a drawdown this summer and has clearly turned the corner recently. Second, corporate earnings for the second quarter were strong, including a buyback announcement. Third, CBOE has tended to usually appreciate amid market stress. The last time world markets suffered a correction greater than 10% was back in late 2015; the MSCI World Index fell 19% until bottoming in mid-February 2016 and the S&P 500 Index declined 14%. Over the same period, CBOE surged more than 20%. In October, the S&P 500 Index fell 7% and CBOE rallied 17.6%.

As the VIX increases, more options-based trading occurs, and therefore greater transaction volume for its operator, the CBOE. The CBOE is the definition of a high-quality business providing historical growth plus very high margins and returns on capital, supported by deep competitive advantages (network effects) and led by a talented management team. I think CBOE will also benefit from long-term cost savings and earnings leverage from its BATS acquisition in 2017.

Volatility has remained near historical lows for the past two years and won’t last forever. Though the VIX has doubled this year, that’s from a major bear market low in late January prior to the global correction. If we enter a standard bear market decline of 20% or more in 2019, or sooner, the VIX is likely to top 48, judging by previous historical stock-market declines since 2009. If that’s the case, CBOE will benefit. But it’s not just the VIX; CBOE is the largest options trading platform in the United States and contract volume surges when volatility erupts. That means strong earnings.

Question: Why not buy the VIX? We’ve traded the VIX ETFs on several occasions, mostly with success, over the past 15-20 years and we’re not fans. The timing is almost impossible, the fees are high, and we don’t like the products. CBOE shares sold off in February following the implosion of several VIX exchange-traded-products (ETPs). While CBOE has no role in managing VIX ETPs, CBOE had been a beneficiary of their success. Credit Suisse is largely to blame for sponsoring an ETP based on the VIX futures and failing to understand liquidity constraints and the relationship to pricing volatility.

I continue to hold gold because of inflation-hedging. I find it rather amazing that the United States, home to the largest deficits in the history of the world, and still spending uncontrollably, can sidestep entitlement reform indefinitely. The events of 2008 are rather difficult to explain in the context of a strong dollar; after all, the epicenter of the financial crisis lay in the dollar and in dollar-based assets, mostly mortgage-backed securities and leveraged loans tied to real estate securitization. But the dollar did post a strong year in 2008 despite these events, though it did fall against the Japanese yen and Swiss franc. We recommend gold because it is outside the confines of the global credit system and remains no



one else’s liability. I also think inflation will make a comeback one day, quite possibly because of growing U.S. deficits and higher interest rates required to attract Treasury investors.

Finally, U.S. Treasury bills now provide the highest yields since 2008. A six-month T-bill yields 2.5% -- not too shabby for cash -- as the Federal Reserve hikes interest rates since December 2015. Cash is an important component of portfolio diversification, particularly at these high asset price levels.

Even the most ardent bulls would have to concede this is a late-cycle bull market. Investors preparing for retirement over the next several years must consider reducing non-essential stock exposure, raise cash levels and introduce portfolio hedges to offset expected rising volatility. Portfolio hedges remain mostly cheap and unwanted in a secular bull market approaching its tenth-year anniversary. The time to protect your portfolio is now.

Value Investing Comes Alive

ENR Market Outlook Portfolio The ENR Market Outlook Portfolio consolidated along with the rest of world markets in an ugly October. Growth-based securities were massacred; many value stocks declined far less or in some cases, posted gains. Defensive sectors fared best with utilities and consumer staples posting gains in October. The MSCI World Index declined 7.42% in October.

The bloodbath in emerging market stocks, currencies and local currency bonds continues. Though the asset class is bombed-out at this point, I still think we’re several months before a real bottom. The Fed continues to tighten, currencies are under pressure and trade disputes between China and the United States cloud the near-term outlook.

Heading into November, value-based securities dominate our portfolio. The iShares Currency Hedged MSCI Japan ETF (NYSE-HEWJ) offers great value from a diversified index of large-cap Japanese blue-chips. The Japanese market is going to outpace Wall Street next year as Nikkei earnings growth finally trounces other major markets.

We’re buying the iShares Edge MSCI International Value Factor ETF (NYSE-IVLU). This non-U.S. basket of securities sells at just book-value and offers geographical exposure in Japan and Europe.

In Europe, we’re buying Azko Nobel NV (Amsterdam-AKZA) ahead of a special shareholder cash distribution. This stock is under heavy hedge fund activist pressure to return cash to investors.

In the United States, we’re focusing on value securities – left to rot amid a massive growth-based bull market. Both the Vanguard Mid-Cap Value ETF (NYSE-VOE) and the iShares Russell Top 200 Value Index (NYSE-IWX) provide far superior risk-adjusted returns over the next 12 months compared to overvalued growth stocks.



After a big earning’s beat last week, we’re placing Canada’s BCE Inc. (Toronto-BCE) on HOLD. This month, we’re selling Dollarama (Toronto-DOL) at a cumulative 66% profit and Invesco KBW Regional Banking ETF (NASDAQ-KBWR) at a modest 1% loss.

The correction in world markets has probably passed its worst phase for now. Ahead of seasonal stock-market strength starting later in November, the resumption of U.S. share buybacks (temporarily halted during earnings season) and the pressure by money-managers to put cash to work as we approach year-end, stocks should post another leg higher. However, as discussed earlier, investors should be pruning non-core stock exposure now, taking realized losses where possible and building cash reserves along with portfolio hedges.

The real threat to markets lies several months from now as companies start to report disappointing earnings and challenging revenues. The Fed’s tightening cycle also complicates matters for investors. We think corporate profits have peaked. Investors should be cautious at this stage of the long-term bull market.

Market Outlook Stock Portfolio:

Security Listed Symbol Entry Price

Date Current Yield

Current Price

Gain/ Loss

Advice

Akzo Nobel Amsterdam AKZA € 79.42 Oct 4/18 3.04% € 74.84 -6.37% BUY

iShares Currency Hedged MSCI Japan

NYSE HEWJ $33.74 Oct 4/18 1.72% $31.21 -7.50% BUY

iShares Edge MSCI Intl Value Factor

NYSE IVLU $24.34 Sep 10/18

2.74% $23.97 -1.52% BUY

Vanguard Mid-Cap Value ETF

NYSE VOE $110.74 Jul 5/18 2.93% $106.96 -2.71% BUY

US Global Jets ETF NYSE JETS $30.67 Jun 12/18

0.46% $30.66 -0.03% BUY

PowerShares Buyback Achievers

NASDAQ PKW $59.30 Mar 6/18

1.22% $58.70 0.64% BUY



iShares Russell Top 200 Value Index

NYSE IWX $52.46 Jan 2/18 2.24% $52.00 0.81% BUY

Invesco KBW Regional Banking ETF

NASDAQ KBWR $53.35 Jun 28/17

2.53% $51.68 -1.98% SELL

Dollarama Inc TSE DOL CAD

23.87 Feb 12/16

0.44% CAD

37.05 66.26% SELL

Flughafen Wien AG

Vienna FLU € 32.00 Aug 7/18

2.00% € 34.30 5.39% HOLD

Verizon Communications

NYSE VZ $47.93 Apr 5/18 4.26% $56.92 21.25% HOLD

BAE Systems plc OTC BAESY $30.25 Dec 4/17 3.43% $27.45 -4.23% HOLD

Huntington Ingalls Industries⁵

NYSE HII $193.55 May 30/17

1.31% $221.03 16.00% HOLD

BCE, Inc.⁴ TSE BCE CAD

57.97 Mar 8/17

5.71% CAD

53.20 3.87% HOLD

PayPal Holdings NASDAQ PYPL $40.10 Jan 3/17 0.00% $83.01 107.01% HOLD

Pfizer Inc.³ NYSE PFE $32.92 Jan 3/17 3.18% $43.25 38.37% HOLD

Nestlé SA² VTX NESN CHF

65.15 Dec 7/16 2.80%

CHF 84.66

31.25% HOLD

Diageo ADR NYSE DEO $113.71 Jul 4/16 0.44% $139.86 30.65% HOLD

Apple Inc¹ NASDAQ AAPL $92.79 May 9/16

1.43% $201.80 123.61% HOLD

General Dynamics NYSE GD $131.37 Mar 31/16

2.10% $177.34 41.99% HOLD

Disclaimer: The ENR Global Contrarian Portfolio owns Nestlé and Apple Inc. ENR Medium Risk Portfolio owns Apple Inc., and Pfizer. ENR Aggressive Growth Portfolio owns Apple Inc. and PayPal Holdings. The ENR International FX Portfolio owns Akzo Nobel NV.

Fixed-Income

Credit Markets Barely Flinch in October Stock Rout but Risks Continue to Rise The U.S. Treasury market failed to rally in October as stocks plunged. Back in February, the same market action occurred,

suggesting the post-1998 negative correlation between stocks and bonds has disconnected in a macro environment of

rising interest rates and creeping inflation. The iShares Core U.S. Aggregate Bond ETF (NYSE-AGG), a leading benchmark

for American investment-grade bonds, declined 0.4% in October, including interest income.

Among the leading economic indicators we track is the price action in the junk bond market. High-yield debt securities

historically top-out before the rest of the credit space and have accurately discounted impending trouble for equities, too.

It’s worth watching. In October, high-yield debt securities declined 1.53% as measured by the iShares iBoxx High Yield



Corporate Bond ETF (NYSE-HYG). Although that’s not an insignificant price decline, the primary trend of the sector remains

intact as of November 6th. But looking ahead, it’s hard to remain sanguine about junk debt; there’s a wave of re-financings

coming due next year and in 2020 alongside higher interest rates. At some point in an advanced economic cycle, default

rates will climb. I expect a bear market in high-yield in 2019 or 2020.

Meanwhile, don’t think you’re any safer in investment-grade bonds. We’ve reported how a huge tranche of fixed-income

securities in the world’s largest investment-grade bond ETFs now hold a disproportionate number of securities barely

rated investment-grade. Bonds rated BBB – the lowest for investment-grade debt – make-up half the investment-grade

index, the most in more than 15 years. Talk about trouble brewing…

Market Outlook Bond Portfolio:


Date Current Yield

Current Price

Gain/ Loss

Advice

iShares TIPS NYSE TIP $113.53 Dec 7/16 3.13% $108.50 -0.17% HOLD

iShares Floating Rate

NYSE FLOT $50.69 Oct 5/16 2.68% $50.87 4.07% HOLD

Disclaimer: The ENR Low Risk Portfolio holds the iShares TIPS Bond Fund and the iShares Floating Rate Bond ETF. The ENR Medium Risk Portfolio holds the iShares Floating Rate Bond Fund.



Foreign Exchange

USD Surges in Late 2018 The U.S. dollar bull market went into overdrive amid market mayhem last month. As most asset classes corrected sharply

in October, the USD Index rocketed 2.28% higher and has now rallied 5.52% in 2018. The only major currencies to post

gains vis-à-vis the buck last month were the Japanese yen and the Brazilian real; the latter managed to record a blistering

8% gain following the election of a hard-right populist. Disappointingly, the Swiss franc dropped more than 3%.

We remain cautious betting against the dollar until the Fed signals a pause in hiking rates. The USD remains at an

advantage versus other majors because the Fed is still tightening while the ECB mulls the end of its QE program in

December; however, recent data in the euro-zone on PMI and inflation might compel the ECB to delay ending its asset

purchases until later next year. Plus, Brexit risks also weigh on the EUR and sterling.

The Chinese yuan also poses possible systemic risks. The Chinese economy is slowing. In October, the monetary authorities

unveiled modest stimulus measures, easing bank capital requirements and bank loan standards. There’s no doubting the

United States and her trade policies are hurting China. In the absence of a trade deal soon, the yuan might decline further,

possibly triggering a global dislocation similarly to August 2015.



Gold Comes Alive

Currency Sandwich Flattened by Surging USD

The ENR Global Currency Sandwich, including gold, declined another 0.25% in October with the yen and gold helping to

soften losses recorded in the zloty, CAD, CHF and EUR. Year-to-date, the ENR Global Currency Sandwich is down 4.56%

versus a rise of 5.52% for the U.S. Dollar Index. Next month, we’ll unveil our 2019 Sandwich participants. I plan on retaining

gold, the yen and the CHF.

2018 ENR Global Currency Sandwich (Equally-Weighted):

Objective: The ENR Global Currency Sandwich attempts to buy-and-hold currencies with the best upside potential against

the American dollar over the long-term, including gold. The following includes performance against the USD in 2018:

• Gold Bullion (-5.8%)

• EUR (-5.2%)

• Canadian dollar (-4.3%)

• Polish zloty (-8.5%)

• Swiss franc (-3.1%)

• Japanese yen (-0.4%)



Commodities

Bullish on Royal Dutch Shell and Oil Production

The oil complex suffered big declines in October’s sell-off with West Texas crude oil plunging more than 13% and Brent

crude falling 8.5%. Natural gas, however, gained 8.3%. The supply of oil is currently abundant but that should change

heading into 2019, despite the U.S. sanctions on Iranian oil. The oil market is almost impossible to forecast; from one day

to the next, inventories fluctuate, and forecasts change. We prefer to focus on well-managed companies in this sector for

the long-term, and where possible, invest in dividend-paying stocks.

Some industry veterans believe the oil sectors’ lack of new discoveries and declining production volumes since 2014 have

created the dangers of an oil shortfall. The chairman of Spanish energy giant, Repsol SA, warned of an oil supply crunch

driven by under-investment. When oil prices spiraled down after 2014, the world’s biggest oil and gas companies tightened

their purse-strings and cut costs as their balance-sheets and stock prices suffered. The industry thereafter shifted funds

into short cycle output, such as U.S. shale oil and gas, aiming to yield production faster and more cheaply, according to

The Financial Times and Repsol CEO, Antonio Brufau.

According to the International Energy Agency, insufficient investment into large, long-term projects will lead to a supply

shortfall in the 2020s just as U.S. shale production peaks. According to Repsol’s CEO, while there are ‘several million barrels

a day of a buffer, in two years this will be exhausted.’

Royal Dutch Shell Class B ADR (NYSE-RDS.B) now trades near its 52-week low after a price correction last month. RDS.B

pays a withholding tax-free dividend to non-U.K. shareholders. That yield is now 5.74% and almost triple the yield of the

S&P 500 Index and almost double that compared to the MSCI World Index. Royal Dutch Shell recently reported earnings.



Cash-flow from operations including working capital movements was $12.09 billion-dollars in the third quarter, the highest

since 2014. The company said it will repurchase $2.5 billion-dollars of shares up to Jan. 28, compared with $2 billion-

dollars in the previous tranche.

The pace of share buybacks has been a key point for investors this year, who are keen for Shell to share the proceeds of

recovering oil prices. The company is now generating more than enough cash to cover dividends and its $25 billion-dollar

repurchase program. Excluding working capital movements, cash flow of $14.7 billion-dollars was the highest in a decade. The Anglo-Dutch energy company dominates the gas business; however liquefied natural gas (LNG) sales were short of

expectations as production fell from the second quarter. Its next big project start-up is a floating LNG facility in Australia

called Prelude, which is expected at the end of the year.

BUY Royal Dutch Shell Class B ADR (NYSE-BRK/B) at market.

Market Outlook Commodity Portfolio:


Date Current Yield

Current Price

Gain/ Loss

Advice

Royal Dutch Shell⁶ NYSE RDS-B $65.51 Nov 5/18 5.74% $65.51 NEW BUY

Uranium Participation Corp

TSE U CAD 4.63 Oct 4/18 0.00% CAD 4.77 3.02% BUY

Pioneer Natural Resources Co.⁶

NYSE PXD $170.17 Mar 8/18 0.22% $148.95 -12.28% BUY

iShares S&P GSCI Commodity Trust

NYSE GSG $16.34 Jan 2/18 0.00% $16.95 3.73% BUY



Schlumberger NYSE SLB $69.75 Dec 31/15

3.88% $51.90 -17.71% BUY

Newmont Mining NYSE NEM $17.99 Dec 31/15

1.73% $32.28 83.85% HOLD

Shareholder Disclaimer: 1. ENR or its employees or its access persons own shares of Apple Inc. 2. ENR or its employees or its access persons own shares of Nestlé

3. ENR or its employees or its access persons own shares of Pfizer Inc.

4. ENR or its employees or its access persons own shares of BCE Inc.

5. ENR or its employees or its access persons own shares of Huntington Ingalls Industries

6. ENR or its employees or its access persons own shares of Royal Dutch Shell B.

Eric N Roseman November 6, 2018 Montréal, Canada

enr market outlook november 2018 - garyscott.com · the 47 acwi component markets, two have already...

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