Full episode: Market Call for Thursday, July 11, 2019
Brian Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities
A tug-of-war between a slowing economy and expectations of more accommodative interest rate policy continues to play out. Stocks and bonds are substitutes for one another, and the role of dividends (or alternatively earnings or cash flow, as proxies for potential future dividend payments) in setting stock prices is analogous to the coupon payment on bonds. So, when interest rates fall sharply as they have recently, the future stream of dividend payments from a group of stocks becomes more valuable. Skeptics refer to this phenomenon as “TINA” (there’s no alternative), meaning that as rates fall ever closer to zero, return-seeking investors are left with little choice but to dial up the risk profile of their portfolios by swapping bonds for stocks. We see low rates as an enduring secular reality of a highly leveraged, low economic growth world and recognize that at the margin these low rates do push up the fair value of stocks.
We acknowledge an ongoing global growth slowdown and the legitimate spectre of a recession on the horizon as the reason for central banks from Brussels to Washington to Ottawa turning more dovish this year. It may seem counterintuitive to talk about recession when job creation is robust, with unemployment rates in Canada and the U.S. near five decade lows, but the onset of a recession is a subtle event, which occurs as the economy peaks, not as it troughs, so by definition, conditions are necessarily at their most ebullient at the onset of a recession. Our expectation is that the next recession will be more of a garden variety rather than a “great recession” or the financial crisis as we saw in 2008 because the buildup of speculative excess and overinvestment that precipitated such a deep, long recession are largely absent in the economy today.
We remain vigilant to domestic and global macroeconomic and geopolitical developments, but recognize that how events unfold in these realms is entirely outside of our control. What we can and do manage is the structure and composition of our portfolios and, as always, these are built very much with a long-term focus. We select companies with strong and well-entrenched competitive advantages within attractive industries that we expect will grow and create shareholder value over a multi-year period, both through recessions and economic expansions. High profitability, disciplined capital allocation policies (modest capital spending, steady dividend increases and share buybacks) and low dispersion in earnings forecasts are some of the hallmark characteristics of our portfolios in general and even more so in recent quarters. This combination of characteristics typically results in superior sales, earnings, cash flow and dividend growth over the medium to long term. Where these fundamentals go, share prices more often than not will follow.
With fertilizer markets still oversupplied, pricing for potash, nitrogen and phosphate remain well below mid-cycle levels, but are slowly recovering. Nutrien meanwhile is expanding its retail network via a series of small acquisitions in their North American stronghold as well as in Australia and South America, reducing the commodity cyclicality of the business and the Northern Hemisphere harvest cycle seasonality.
TD BANK (TD.TO)
Trading at 10.4 times expected earnings, TD looks well poised to continue its consistent pattern of outperforming the TSX, a feat that it and other members of the Canadian banking oligopoly have accomplished in 20 of the last 25 years.
Manulife yields 4.2 per cent and trades at 1.1 times book value, which is discounted both versus other Canadian life insurers and relative to its long-term average trading multiples. We expect this gap to close, as the new CEO is quickly establishing credibility while the company makes steady, measurable and rapid progress towards its five strategic priorities: expense efficiency, freeing up regulatory capital, accelerating growth in targeted segments, driving leadership in digital engagement with customers and top quartile employee engagement.
PAST PICKS: AUG. 1, 2018
PAREX RESOURCES (PXT.TO)
- Then: $22.85
- Now: $21.16
- Return: -7%
- Total return: -7%
Sold April 2019 at $65.64. George Weston spin-off on Nov. 2, 2018. Distribution ratio of 0.135:1.
- Then: $67.93
- Now: $67.22
- Return: 23%
- Total return: 25%
BROOKFIELD ASSET MANAGEMENT (BAMa.TO)
- Then: $54.27
- Now: $63.46
- Return: 17%
- Total return: 19%
Total return average: 12%
GOODREID NORTH AMERICAN BALANCED
Performance as of: June 28, 2019
- 1 year: 3.0% fund, 2.8% index
- 3 years: 8.7% fund, 5.8% index
- 5 years: 6.3% fund, .2% inddex
Index: Morningstar Canadian Equity Balanced Category Average. Figures include reinvested income and are net of fees.
- Canadian equities: 32%
- U.S. equities: 39%
- Canadian fixed income: 18%
- Cash: 11%