Douglas Kee, chief investment officer of Leon Frazer & Associates

Focus: Canadian dividend stocks

MARKET OUTLOOK

Major global economies peaked in late 2017 and have trended down even since. The Purchasing Managers’ Index has declined from a high of 54 to around 52, led by moderating growth in China, Japan and Europe. Offsetting these declines was the continued strength in the U.S. and Canada. We expect North American growth to moderate in 2019 given the effects of higher interest rates and declining liquidity. Employment growth remains robust especially in the U.S. and wage pressures are building but still remain quite low. Canada’s growth will be challenged in 2019 due to a moderating housing market and declining business investment in the energy sector. 2019 growth will be lower and in an expected range of 2.0 per cent to 2.5 per cent.

With a moderating economy and inflation running near a 2.0 per cent target, the U.S. Federal Reserve has indicated that there may be fewer rate hikes in 2019 than previously expected. We do expect a 25 basis points (bps) bump on Wednesday but the Fed may indicate a wait and see data dependent strategy for next year. The Bank of Canada will follow the Fed’s lead on the magnitude of rate hikes as they don’t have any flexibility with the soft Canadian dollar.

Recently bond yields have trended down with the U.S. 10-Year Bond Yield dropping from 3.25 per cent to 2.85 per cent. This is reflecting the economic slowdown prospects and potential trade war fears. There is a disconnect here with the supply side of the equation where the combination of quantitative tightening and deficit financing may pressure rates up.

Over the last few weeks the U.S. equity market has been pasted, wiping out the positive gains year-to-date. The S&P 500 is now trading at the low end of our valuation range and testing support levels. The S&P/TSX peaked much earlier in the year with oil prices and is now testing at valuation and support levels as well. Earnings momentum has peaked and our expectation is that earnings growth for 2019 will be in the five per cent to 10 per cent area, down from about 20 per cent expected for 2018.

We have been cautious on the equity market this year and have accumulated some cash through dividends as well as by trimming positions. We favour companies in our backbone sectors such as banks, utilities, pipelines and telecom services. These companies provide current income and superior dividend growth prospects.

TOP PICKS

FORTIS INC. (FTS.TO)

Last purchased stock at $46.00.

• Would prefer to buy stock in the $42.00 to $44.00 area, stock price has run up recently with lower bond yields and hot money buying defense
•  Current yield at 3.9 per cent, one year dividend growth of 6.0 per cent and five year growth of 8.0 per cent annualized. Expect 6 per cent dividend growth in 2019
• Company is geographically and regulatory diversification in Canada, U.S. and the Caribbean. Strength in electric distribution, transmission and gas distribution
• Five year capex program of $17 billion primarily funded through cash flow, regulated debt, asset sales and dividend reinvestment plan (DRIP).
• Six per cent to seven per cent rate base growth back stops earnings and dividend growth

TRANSCANADA (TRP.TO)

Last purchased stock at $53.00.

• Current yield of 5.2 per cent, one year dividend growth of 8.0 per cent and five year growth of 9.0 per cent annualized. Expect 8.0 per cent dividend growth in 2019
• Well diversified (Canada, U.S. and Mexico) in natural gas and oil transmission, gas gathering, power generation and storage. 95 per cent regulated or long-term contracts
• Contracted growth of approximately $24 billion to 2023. Funding of capex primarily through cash flow, regulated debt, asset sales and DRIP
• Large pending projects include Coastal GasLink and Keystone XL, funding may well include JV Partners

ROYAL BANK OF CANADA (RY.TO)

Last purchased stock at $94.00.

• Current yield at 4.2 per cent, one year dividend growth of 8.0 per cent and five year growth of 7.5 per cent annualized. Would expect dividend hike of five per cent plus in 2019
• Canadian personal and commercial bank represents approximately 50 per cent of revenue, has scale and is self-funding. RBC’s emphasis on cost control and technology has improved overall efficiency.
• The bank has significant exposure to higher margin businesses such as capital markets, wealth management, insurance and treasury in Canada, U.S. and Europe
• Tier 1 Capital is at 11.5 per cent and growing at approximately 20 bps per quarter giving Royal the ability to grow the business, increase dividends or buyback shares

PAST PICKS: DEC. 6, 2017

SCOTIABANK (BNS.TO)

• Then: $81.81     
• Now: $71.20      
• Return: -13%     
• Total return: -9%

SUN LIFE FINANCIAL (SLF.TO)

• Then: $51.65     
• Now: $44.43      
• Return: -14%     
• Total return: -11%

AGRIUM (AGU.TO)

Merged to become Nutrien (NTR.TO)

• Then: $133.83   
• Now: $61.52      
• Return: 3%
• Total return: 5%

Total return average: -5%

WEBSITE: leonfrazer.com