Oct 24, 2016

Michael Underhill's Top Picks: October 24, 2016

BNN Bloomberg

Michael Underhill , BNN

Michael Underhill, founder and chief investment officer of Capital Innovations LLC

Focus: Global agriculture, timber and infrastructure stocks
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MARKET OUTLOOK
The price of “real assets” (real estate, commodities and collectibles) relative to “financial assets” (stocks and bonds) are at their lowest since 1926. We would suggest "buying humiliation and selling hubris" since investors are being forced to discount higher inflation and interest rates, as protectionism and redistribution themes are aimed at boosting Main Street at the expense of Wall Street.

THE CASE FOR REAL ASSETS
Our themes of “peak liquidity,” “peak globalization” and “peak inequality” argue for small absolute returns from financial assets but big rotations across markets.

The 2016 to 2017 policy flip from quantitative easing, zero interest-rate policy and negative interest-rate policy, to less monetary stimulus and more fiscal stimulus, reflects rising political pressure to reduce wealth inequality. The protectionism and redistribution themes are also aimed at boosting Main Street at the expense of Wall Street, so investors are being forced to discount higher inflation and interest rates. Inflation is indeed moving higher: China’s PPI turned positive in September for the first time since 2012, and the United States reported increasing inflation recently, while the Bank of Canada reports talks of lowering rates.

Policy, profit and positioning trends all argue for rotation from "deflation" to "inflation," from "ZIRP winners" to "ZIRP losers," from Wall Street to Main Street. As part of this rotation, we expect real assets to outperform financial assets.

5 REASONS TO BUY REAL ASSETS
Unprecedented monetary easing since the Global Financial Crisis has caused the prices of financial assets to soar, while real assets have lagged the appreciation. Other examples of the extreme outperformance of financial assets: U.S. stocks are very close to all-time highs versus U.S. house prices, and U.S. bonds are at all-time highs versus diamonds.

Investors should always buy humiliation and sell hubris. Today, the humiliation is very clearly commodities, while the hubris resides in fixed-income markets.

BUY HUMILIATION, SELL HUBRIS
Price of real assets (real estate, commodities and collectibles) relative to financial assets (stocks and bonds) is at its lowest level since 1926; U.S. stocks close to all-time highs versus U.S. house prices; U.S. bonds at all-time highs versus diamonds; 10-year rolling return from commodities lowest since 1933.
PEAK DEFLATION
Real assets positively correlated with inflation; stocks and bonds negatively correlated with inflation; central banks are withdrawing stimulus as deflation fears subside; real assets hedge against inflation and monetary tightening; real asset relative performance has 82 per cent correlation to Fed funds rate since 1950.
WAR ON INEQUALITY
Commodities, real estate and infrastructure are natural beneficiaries of a “war on inequality” waged via fiscal stimulus.
CHEAP VALUE
Real estate (REITs 3.3 per cent, timber 2.6 per cent, agriculture 2.6 per cent) and infrastructure (3.2 per cent) are higher-yielding assets than global stocks and bonds.
POSITIONING
Asset allocation to real assets is low but on the rise (just 8.2 per cent of total ETF market cap is exposed to real assets; pension fund up from nine per cent to 24 per cent over the past 15 years).

CATALYSTS TO WATCH

Inflation
Employment
Election results
Price of oil
Economic figures/GDP

U.S. PRESIDENTIAL CANDIDATES’ ENERGY AND INFRASTRUCTURE POLICIES
The candidates differ most on policies that might affect stocks in the healthcare, energy and financial services sectors. Outlined below are Hillary Clinton and Donald Trump’s policies regarding energy and infrastructure investment.

HILLARY CLINTON

Boost spending by an extra $275 billion over next five years, financed through business tax reform.
Set up a National Infrastructure Bank.
Reinstate Build America Bonds program, which offered subsidies or tax credits to incentivize investment.
Support renewable energy production, including a significant increase in solar capacity, with $60 billion in projects and competitions.
Allow clean energy production on federal lands.
Increase public investment in clean energy infrastructure and related R&D programs.
Strengthen efficiency/pollution standards; cut methane emissions; reduce oil consumption.
Cut tax benefits for oil and gas companies.
Spend $30 billion to support and invest in coal communities.

DONALD TRUMP

Increase infrastructure spending by a substantial but unspecified amount; has suggested his plan would exceed Clinton’s in size.
Promote energy independence.
Allow leasing of energy resources on federal lands.
Lower drilling restrictions and increase shale exploitation.
Allow new coal mining leases on federal lands (currently under moratorium); revisit other coal regulations.
Revive Keystone Pipeline project.
Eliminate Clean Power Plan, Climate Action Plan, and the Waters of the U.S. rule.
Abandon Paris Climate Change Agreement; cease U.S. funding of UN climate change programs.

TOP PICKS

U.S. STEEL (X.N) – Price target US$25.00
Meaningful movements in steel input costs and steel prices normally trigger significant shifts in supply and prices. We believe the spike in met coal prices will result in an increase in steel scrap and steel sheet prices over the next few months. As met coal prices jump, integrated steelmakers globally will try to initially offset the rise in met coal costs by increasing the scrap charge in their basic oxygen furnaces (BOF) to substitute for the amount of pig iron — and therefore the amount of met coal —needed to produce steel.

BARRICK GOLD (ABX.N) – Price target US$25.00
ABX will be releasing strong third-quarter results this week as the company is set to witness a 60 per cent jump in its margins on each ounce of gold. On one hand, Barrick Gold's upcoming results will give the stock a shot in the arm due to substantial margin improvements over last year, while on the other, its long-term prospects appear to be in good shape due to its focus on enhancing production from core assets. As such, it will be a good idea to remain invested in Barrick Gold shares going forward since better pricing and lower costs will lead to more upside.

KINDER MORGAN INC. (KMI.N) – Price target US$24.00
We believe positive 3Q factors across the sector could be stronger-than-expected oil prices compared to some guidance levels, possible basis capture by some oil pipeline/storage operators, volume increases from additional activity in key basins (Permian, SCOOP/STACK), and continued cost management. KMI saw balance sheet progress in 3Q with outlook for year-end, CO2 results/outlook and hedge position, project progress, contract updates on some gas pipes in base business. Potential year-end 2017 balance sheet commentary.

DISCLOSURE	PERSONAL	FAMILY	PORTFOLIO/FUND
X	N	N	Y
ABX	N	N	Y
KMI	N	N	Y

PAST PICKS: JULY 2, 2014

ENERGY TRANSFER PARTNERS (ETP.N)

Then: $58.02
Now: $37.06
Return: -36.12%
TR: -21.54%

WHITEWAVE FOODS (WWAV.N)

Then: $32.09
Now: $54.62
Return: 70.22%
TR: 70.22%

INTERNATIONAL PAPER (IP.N)

Then: $49.64
Now: $47.11
Return: -5.08%
TR: 2.98%

TOTAL RETURN AVERAGE: +17.22%

DISCLOSURE	PERSONAL	FAMILY	PORTFOLIO/FUND
ETP	N	N	Y
WWAV	N	N	Y
IP	N	N	Y

FUND PROFILE: RIDGEWORTH CAPITAL INNOVATIONS GLOBAL RESOURCES AND INFRASTRUCTURE FUND

PERFORMANCE AS OF OCTOBER 21, 2016:

1 month: Fund 5.87%, Index* 4.32%
1 year: Fund 5.25%, Index* 6.38%
3 year: Fund -2.48%, Index* -26.80%

* Index: S&P Global Natural Resources Index
* Returns net dividends and fees

Four Star Award from Morning Star for the three-year period of September 20, 2013 to September 30, 2016 in the Natural Resources category. Lipper has also ranked the fund in the top 20 per cent of all funds in the peer group.

TOP HOLDINGS AND WEIGHTINGS