Jun 6, 2018

Andrew Pyle's Top Picks: June 6, 2018

BNN Bloomberg

Andrew Pyle , BNN Bloomberg

Andrew Pyle, senior wealth advisor and portfolio manager at Scotia Wealth Management
Focus: North American equities

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MARKET OUTLOOK

North American markets again starting to look frothy, but excess euphoria as we saw in early January isn’t present thanks the shakeout of short volatility plays and a risk-averse retail segment. Provided we see a calming down on global trade issues and North Korea/Iran, fundamentals support an extension of the second quarter rebound. Look for the S&P 500 to grind higher by 4 to 5 per cent over the third quarter with some resistance kicking in near 2,800 and then the January highs around 2,850. Similarly, TSX has scope to move towards 17,000 in the third quarter with initial resistance about 300 points away at 16,350.

The second half is where things get tricky. If tightening by the Fed and the Bank of Canada is subdued (two hikes each after the upcoming FOMC), then we could see a further gradual extension or consolidative trading into year-end. If the expected trajectory for hikes steepens then another wave of selling in bonds brings forward the timing for a North American economic slowdown/correction.

If we simply matched the longest stretch between cycle troughs in U.S. year-over-year growth, that would place the next trough in the first quarter of 2020. Assuming a technical cyclical downturn of two quarters that would mean we’d potentially be heading into one by the summer of 2019 and that would be more likely with a higher-rate structure. For this reason, I view the next leg of this rally as potentially the last or at least the last decent done.

This theme also links into another theme regarding the interest rate cycle. If the fundamental backdrop for the U.S. economy begins to show cracks in the second half then this would reinforce the expectation of only two more Fed hikes by year-end, which are largely priced into a 3 per cent 1-year U.S. yield. Depending on the tone of next week’s statement, this might be a near-term top, similar to how we drifted back from just above 2.5 per cent in March of last year down towards 2 per cent before the next move higher. The risk is that the tone is more bullish and we see continued strength in Q2 and Q3 GDP, which could send yields up to the 3.6 per cent area (high in early 2011). Note that 3.25-3.30 per cent would represent a 50 per cent retracement of the rally in the 10-year from the 5.2 per cent high in 2007.

If the negative risk plays out this again would advance the timetable for an economic pullback in the U.S. and Canada. Stocks are already feeling some competition from current yields so another half a percent would give investors reason to look for alternatives to risk assets. This is particularly true given that next year we will have tied the longest rally in history without a significant pullback.

My view is that this rate cycle caps out between here and 3.5 per cent, making a rotation into bonds look more attractive as we move through the second half of the year. This should also lend some support to dividend stocks, particularly in utilities.

TOP PICKS

FORTIS (FTS.TO)

Lower risk and strong fundamentals in the regulated utility space. While there’s some credit pressure this year, mainly from impact of U.S. tax changes, I believe the stock looks reasonably valued at just over $40, maybe with a tight stop around $39.

BCE (BCE.TO)

Stock reflects the expectation of slower wireless growth in 2018, but growth in average revenue per user (ARPU) is still decent. Dividend yield of 5.3 per cent with one-year dividend growth of 5 per cent now looks very attractive with shares coming off May lows below $53. Stock hasn’t traded below $51.50 since 2014.Wouldn’t get greedy on a move higher given resistance in the $63 to $64 area and potential for general market correction.

RBC (RY.TO)

While lower excess capital and a decline in tier 1 capital ratio to below 11 per cent, this is still almost three points above the required level. I like TD and BMO in this space as well, but their valuations have become stretched on the rebound from Q2 lows. Bank still holding out prospect for buybacks in 2018 and dividend yield indicated above 3.8 per cent, higher than TD and BMO.