Yahoo Finance How the Bank of Canada could cure inflation — and four other market thoughts
It’s the last week of September and my brain is still in a bit of a summer fog, so I can’t quite connect five points on a single theme this week. Instead, here are five random market musings.
Greed might be back
Despite an overwhelming sense of dread overcoming most investors, with continued worry about a recession, inflation and interest rates, we are starting to see some signs that greed might be returning. Now, greed and worry don’t necessarily match, but greed is always prevalent, somewhere, in any type of market environment.
Case in point, VinFast Auto Ltd., a $41-billion Vietnamese electric-vehicle company that delivered a whopping (we jest) 9,535 vehicles in the second quarter. Of course, all things EV are hot, and, after a pulled IPO last year, the stock finally got listed this year. From a low of US$9 in early August, it soared to US$93 by the end of August. At that level, it became the second-largest automaker in the world, behind only Tesla Inc. Investors (and we use that term lightly here) got themselves into a frenzy.
Greed, for a while, was back. The only positive here is that reality at least set in — quickly. Following news of more insider selling, VinFast’s stock is now US$18, down 81 per cent from its peak less than a month ago.
SPACs are dead
Investors in special purpose acquisition companies give a group of managers a bunch of cash and then give them two years to make an acquisition with that money. Investors have no idea what will be bought (though the deals need shareholder approval). If nothing is bought, investors get their money back. Essentially, it is like giving a kid a bunch of money to go into a candy store. They might be conservative and buy one candy bar, or they may go crazy and buy everything in the store, leading to a sugar crash.
Giving random managers a bunch of money to buy whatever they want is not a good investment strategy
VinFast, discussed above, went public via a SPAC. Investors buy into SPACs in the hope that management will make a great acquisition, so they get in early on a newly public company. This can happen once in a while, but let’s look at the big picture here.
Of the 400 SPACS that have done deals since the start of 2020, 15 have gone completely bankrupt and 160 are down more than 80 per cent. Here are SPACs’ annual average returns recently: 2019: minus 40 per cent; 2020: minus 38 per cent; 2021: minus 65 per cent; 2022: minus 61 per cent; this year to date: minus 50 per cent. As it turns out, giving random managers a bunch of money to buy whatever they want is not a good investment strategy.
IPOs are back
A bit contrary to the two thoughts above, but initial public offerings are finally making a bit of a comeback this year. We have watched Arm Holdings PLC and Instacart (under Maplebear Inc.) go public in the past month, amongst some other lower-profile deals. IPOs are exciting and great for underwriters (large fees). The problem, though, is they offer a mixed view on the market’s outlook.
Some investors view more IPOs as a sign that the market is healthy since investors are finally willing to take a chance on new companies. Others see more IPOs as a sign of a market peak, as insiders of private companies decide to cash in on high valuations. So, like any market indicator, IPOs can send mixed messages.
We tend to think, the recent activity so far is a positive sign for the market. It is good that companies can raise money, and we are nowhere near the frenzied IPO pace of some other historical market cycles.
Bank of Canada could cure inflation
Stay with us on this one. In the calculation of the consumer price index (CPI), shelter is a fairly major component. Of note, mortgage interest costs have risen 30 per cent in the past year as the Bank of Canada sharply and quickly raised interest rates. But one of our analysts at 5i modelled out that if Canadian five-year yields drop by 1.5 percentage points over the next six months (four per cent to 2.5 per cent), the shelter component goes from a year-over-year increase of 6.3 per cent to two per cent, just on year-over-year mortgage interest costs alone. Thus, a drop in interest rates could lower inflation.
Now, there is more to it than that, of course, but our point is that a big part of the inflation index is housing, and the central bank itself has caused this component to rise. Most other parts of the inflation index have declined (excluding energy), or at least stopped rising. If rates — and, thus, housing costs — decline, CPI could become even more under control.
What’s up with the energy sector?
We get questions every day from our customers on energy stocks. They all ask the same thing: “If oil is at a one-year high, how come my oil stocks aren’t doing anything?” Frankly, we have a very hard time answering this.
On average, energy companies are very cheap, have improved their balance sheets dramatically, are rolling in cash flow, pay good dividends and are growing production. The energy sector is now up on the year, after big declines earlier. It is at least ahead of the S&P/TSX composite’s year-to-date return. But considering its high dividends and low valuations, we are quite surprised there is not a lot more interest in the sector.
It looks like investors are worried about a recession, or the Organization for the Petroleum Exporting Countries turning its taps back on. But neither of those worries seem likely to happen at this point. Why aren’t more investors interested in the energy sector? Good question.
Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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