Full episode: Market Call Tonight for Wednesday, January 9, 2019
Brian Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities
2018 came to a dramatic close, with sharp losses in the Canadian and U.S. stock markets as festering concerns about waning economic growth, rising interest rates and dysfunctional government finally came home to roost. The S&P/TSX Composite index incurred a loss of 10.1 per cent during the fourth quarter, erasing the year’s gains as the ink dried on 2018’s total return of -8.9 per cent.
While we were disappointed by the equity market weakness late in the year, we weren’t entirely surprised by it and had been taking steps to de-risk portfolios over the course of the last five quarters to position for the late stages of the economic cycle. We did this knowing that sentiment is a contrarian indicator, meaning that when the hue and cry is loudest to be “all in,” the prospective returns are lowest.
Rather than try to gauge the nebulous investment sentiment, we simply recognize that equity investors supply the risk capital in the economy and thus own the profits. Because the economy and therefore profits grow over time, stock prices rise inexorably, albeit in an irregular zig-zag fashion.
Time in the market is the investors’ friend, whereas timing the market is a glorified coin toss. Like it or not, we know periodic losses are normal, but they’re outnumbered and significantly outweighed by gains particularly as the benefits of compounding accrue over a long span of time. We simply strive to be “less bad” in difficult markets and “better” in strong markets. The other obvious implication after a quarter like the most recent is that prices, valuation and sentiment are all markedly lower and thus prospective returns are correspondingly higher.
As we think about the major forces at work in the Canadian and U.S. economies in 2019, we see a number of puts and takes. On the positive side, unemployment is at or near record lows while wage inflation remains at healthy, but not unduly inflationary levels. We see some urgency as it relates to competitiveness in Canada and particularly in Alberta, where a plan is taking shape to alleviate crisis-level oil prices. In the U.S., business confidence surveys continue to indicate expansion although the pace of growth in corporate earnings necessarily will moderate after being goosed significantly by tax reform.
Finally, on a “micro” level, we see silver linings for many of the companies we own amidst a more difficult economic environment. This isn’t merely wishful thinking, but the intended consequence of constructing a “best-of-breed” portfolio, which is subtly but crucially different from a purely defensive portfolio. Great companies are like great athletes: they snatch victory from the jaws of defeat and they find ways to win even against very long odds sometimes.
Latest purchase in December 2018 at $69.78.
Scotiabank is Canada’s third-largest bank and the nation’s most globally ambitious, with a long established footprint in Mexico, Latin America, the Caribbean and Asia. Scotiabank earns a 14.4 per cent return on shareholder’s equity and has grown earnings per share at a 7 per cent compound rate over the last five years, with commensurate increases in its dividend. The company has the largest exposure to fast-growing and “underbanked” emerging markets among the Big Six banks and has internal efficiency levers to pull in driving superior earnings growth over the next several years. The bank has aggressively deployed capital recently, with deals including the $2.9 billion acquisition of BBVA’s Chilean bank and the purchase of Jarislowsky Fraser and MD Management. Trading at a 19 per cent discount to its 10-year average with a price-to-earnings ratio of just 9.3 times 2019 expected earnings and yielding 4.9 per cent, Scotiabank is well poised to continue its consistent pattern of outperforming the TSX.
BROOKFIELD ASSET MANAGEMENT (BAMa.TO)
Latest purchase in December 2018 at $53.23.
Brookfield is one of the world’s foremost managers and operators of alternative assets, with deep expertise in sourcing transactions and surfacing value in long-duration real assets like real estate, private equity, infrastructure, renewable energy and utilities. With significant assets in Canada, the U.S, U.K., Australia, Brazil and India among others, the company has tremendous reach and geographic diversity and can source transactions globally. Brookfield’s size and scale allow them to field expert teams with deep operating experience in their respective industry verticals and geographic areas. Their financial strength and variety of funding sources afford them the advantage of being among the first calls sellers of world-class assets make when looking to make a transaction. Demand for alternative assets is outstripping demand for traditional stocks and bonds and Brookfield has accordingly been enjoying consistent and large inflows of assets. At their recent investor day, Brookfield unveiled a new tactic in their relentless quest to drive shareholder value: share buybacks, which their forecasted $40 bilion of free cash flow over the next decade should allow them to execute upon comfortably.
PAREX RESOURCES (PRX.TO)
Latest purchase in December 2018 at $14.44.
Parex is a mid-sized, rapidly growing oil producer operating in Colombia. Parex enjoys some of the highest netbacks (operating profits) of any mid- to large-sized Canadian energy producer. The company has more than tripled production since 2013, and ended 2018 producing over 49,000 barrels of oil per day as they continuing drilling out their land blocks. Crucially (and refreshingly for a resource company), the management team is very focused on profitability, such that commensurate with its prolific growth in production, earnings have more than quintupled and the return on shareholders’ equity in the latest quarter surged to 52 per cent. With a mere $10 million of debt and $360 million in cash on their books, Parex is well positioned to fund their capital program, enabling further production and cash flow growth. They’ll be also able to execute aggressively on their share buyback program, which had been suspended until recently amid an aborted sale process, which churned the shareholder base fairly significantly and created an excellent value-buying opportunity for these shares.
PAST PICKS: JAN. 17, 2018
Sold July 2018 at $223.49.
- Then: $142.72
- Now: $196.36
- Return: 38%
- Total return: 38%
- Then: $98.14
- Now: $92.27
- Return: -6%
- Total return: -5%
- Then: $81.60
- Now: $70.47
- Return: -14%
- Total return: -10%
Total return average: 8%
Goodreid North American Balanced
Goodreid’s balanced approach allows investors to participate in the potential growth of equity holdings while mitigating risk through ownership of quality fixed-income instruments.
Performance as of: Sep. 30, 2018
- 1 year: 8.5% fund, 3.7% index
- 3 years: 9.0% fund, 6.0% index
- 5 years: 9.4% fund, 5.8% index
INDEX: Globe Canadian Equity Balanced Peer Index Average.
Returns are net of fees and reinvested income.
- Canadian equities: 31%
- U.S. equities: 39%
- Canadian fixed income: 19%
- Cash: 11%