Gavin Graham, contributing editor at The Income Investor Newsletter
Focus: North American and global large caps

MARKET OUTLOOK

With the S&P 500 up 9 per cent for the year against the S&P/TSX's flat performance, investors in U.S. stocks have done well, but the strength has been narrow and concentrated in technology stocks, mainly in the highly valued FAANG stocks. With U.S. short term rates up to 2.25 per cent and other three increases over the next year at least indicated by the U.S. Federal Reserve's dot-plot forecast, stocks face increasing headwinds. With investors able to get a risk-free 2.8 per cent in two-year U.S. Treasuries, and with the yield curve between two-year and 10-year U.S. bonds narrowed to only 0.2 per cent, past experience suggests the yield curve will invert soon, which has always been a precursor of under-performance by equities. Meanwhile, Canadian short-term rates have tripled from 0.5 per cent to 1.5 per cent and are likely to rise further due to the excellent news of a NAFTA dispute resolution. This has led to underperformance of interest-rate sensitive sectors such as utilities, pipelines and REITs, which now look attractive, as do energy stocks with the rise in oil and gas prices and the announcement of Royal Dutch Shell's $40 billion LNG project expected this week. Investors should be taking profits on sectors that have performed particularly strongly, such as technology, raising cash and buying short-term debt, while retaining exposure to non-correlated assets such as infrastructure and gold. The latter looks especially attractive, given its lacklustre performance at a time of rising inflation and geopolitical tensions such as the Iranian sanctions, Italian budget worries and Russia’s aggressive attitude.

TOP PICKS

SCOTIABANK (BNS.TO)
Most recently recommended on Sep. 22 at $78.

The third-largest Canadian bank, Scotia generates over 30 per cent of its revenues and earnings from international operations, primarily in the four Pacific Alliance countries of Mexico, Colombia, Peru and Chile, where it recently purchased BBVA's operations to become the second-largest private bank. It’s also in the Caribbean and Asia. Scotiabank has been expanding its wealth management operations, buying pension manager Jarislowsky for $1 billion and doctors’ fund manager MD Financial for $2.5 billion this year. The equity issued for these acquisitions has led the stock falling 8 per cent, making it the worst performer amongst the major banks, a situation, which almost always sees outperformance the following the year. It yields 4.4 per cent and remains the lowest-cost operator.

INTERRENT REIT (IIP_u.TO)
Most recently recommended on April 15 at $10.75.

InterRent owns apartments in Ottawa (32.5 per cent), the GTA including Hamilton (31.5 per cent) and secondary cities in Ontario and Montreal (16 per cent), with almost 9,000 units worth over $1.6 billion. Management has expanded rapidly by buying undermanaged apartments, upgrading them and improving the tenant mix. The number of apartments has almost doubled since Mike McGahan assumed control of management in 2009 while average rentals have risen 38 per cent to $1,110 per month. Occupancy was 97.9 per cent in 2017, operating income $66.2 million and adjusted funds from operations (AFFO), the REIT equivalent of earnings per share, was $30.6 million ($0.38 per share), which means the $0.27 distribution represents conservative 65 per cent payout ratio. With continued immigration into southern Ontario and limited supply, the strategic fundamentals for InterRent remain strong. Its strong performance has been recognized, up 47 per cent in the last year, but the outlook remains attractive. It yields 2.3 per cent.

BORALEX (BLX.TO)
Most recently recommended on July 26 at $20.12.

Boralex is one of the largest independent renewable power producers with operations in France (48 per cent of capacity), Quebec (31 per cent), the U.S. and Ontario as well as a concentration on wind power (85 per cent) and hydro (11 per cent). With the recent acquisition of Kallista (168MW) in France and Invenergy (201MW) in Quebec this year, Boralex has 1.820MW in installed capacity and projects underway that will allow it to reach its target of 2,000MW in 2020. EBITDA is running at an annual rate of $420 million this year and forecast to be $490 to $510 million in 2019. The shares are down 16 per cent in the last year and 13 per cent in the last three months, when the new government in Ontario cancelled some projected facilities. This seems like an overreaction, given its limited exposure (15 per cent) and that existing facilities are not affected. It yields 3.5 per cent.

PAST PICKS: SEP. 29, 2017

FAIRFAX FINANCIAL (FFH.TO)

The company has realized large gains on its Asian insurance business while still retaining a minority shareholding and the AWG purchase in 2017, its largest ever, gives it greater geographical and business diversification.

• Then: $649.33
• Now: $688
• Return: 6%
• Total return: 8%

SLATE RETAIL REIT (SRT_u.TO)

This REIT, which is a play on the U.S. grocery-centered shopping malls, has lagged, with a negative return of 4 per cent over the last year. But the strong performance of supermarkets such as Kroger, their largest tenant, indicates that food retailing should remain resilient even in the face of competition from Amazon.

• Then: $13.41
• Now: $12.68
• Return: -5%
• Total return: 3%

CALIAN GROUP (CGY.TO)

Calian is a provider of health, IT and training services to governments and businesses, including satellite base stations. It’s up 6 per cent and continues to gain new contracts.

• Then: $28.60
• Now: $30.12
• Return: 5%
• Total return: 9%

Total return average: 7%

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