Full episode: Market Call for Thursday, April 9, 2020
Brian Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities
The economic measures taken by governments around the world are akin to placing a patient in an induced coma to promote a good medical outcome. Workers have been told to stay home, so the massive unemployment occurring is self-induced. Accordingly, we differ from the dire prognosticators in assessing the COVID-19 aftermath. This is neither a cyclical recession caused by tight monetary policy or inventory de-stocking nor a structural recession, but an event-driven recession. While there will be widespread economic dislocation, the recovery will likely be swifter than other recessions.
Unprecedented support systems have been invoked, with a $2 trillion federal stimulus package from U.S. Congress to support businesses and a similarly large package from the Canadian government. This fiscal stimulus approximates 10 per cent of each country’s GDP and buys time for more COVID-19 testing, treatment development and vaccine research. Modern economies run on credit and confidence and starving an economy of either is like depriving a fire of oxygen. Regulators have tasked banks to allow borrowers to defer mortgage payments, ease lending covenants and to lower credit card rates, with assurance that central banks “have their backs.” While the depth and breadth of the recession will be epic, it is unlikely to be long. We could see social distancing relaxed once health authorities are confident the virus is contained. From there, growth in the food service sector would be astronomical as revenues rebound from zero, though without immediately returning to pre-crisis levels. As low-income workers tend to spend nearly 100 per cent of their incomes, the effect from these furloughed workers returning to work and normal spending patterns would be large. A general improvement in consumer and business confidence could develop as safety concerns fade, paving the way for hiring and business investment. The scenario is theoretical, but an otherwise healthy “patient” can be revived and return to normal daily life without lasting damage.
Analysts forecast S&P 500 earnings of $151 in 2020 versus 2019 earnings of $152, so the S&P trades at 17.8 times expected earnings. Take this with a grain of salt, as analysts are often wrong at major turning points. Stock markets are a discounting mechanism, and they turn up before corporate earnings, just as they did in 2009. Then, stocks were priced off of the net present value of the expected stream of earnings that would follow that date. With hindsight, we know S&P 500 earnings tripled since then. We don’t “rent” stocks for this quarter: We own them to benefit from growing earnings that flow from their assets. It would be wrong to price a company strictly off of one year’s expected earnings, particularly at recessionary extremes when those assets are under-earning. Instead, we normalize current earnings to mid-cycle levels by averaging earnings over the last 10 years or by applying an expected long-term average return on shareholder’s equity to the company’s productive assets. On that basis, we think the mid-cycle earnings power of the S&P 500 is between $112 and $144. The index is trading somewhere between 19 and 24 times normalized earnings, which is a meaningful discount to its 30-year average price to normalized earnings ratio of 27 times. Times are tough, but Canadian and U.S. stock prices now afford investors a very good prospective return.
ALIMENTATION COUCHE-TARD (ATD/B TSX)
Last purchased on March at $42.27.
ROYAL BANK (RY TSX)
Last purchased on March at $83.69.
CGI GROUP (GIB/A TSX)
Last purchased on March at $94.49
PAST PICKS: APRIL 11, 2019
RESTAURANT BRANDS INTERNATIONAL (QSR TSX)
- Then: $88.31
- Now: $63.02
- Return: -29%
- Total return: -26%
SUNCOR (SU TSX)
- Then: $43.88
- Now: $23.63
- Return: -46%
- Total return: -44%
RIOCAN REIT (REI/U TSX)
Sold in January at $27.41.
- Then: $26.32
- Now: $18.21
- Return: -31%
- Total return: -27%
Total return average: -31%