Peter Brieger, chairman and managing director at GlobeInvest Capital Management
Focus: North American large caps
We are almost nine years into the North American market and economic recoveries. Given the relatively high valuations for stocks and perceived weakness in some recent economic data, worries about continuing longevities are surfacing. For example, there is a school of thought that observes that many economic data points are about above their 2007– 08 highs. Recently, they have had pullbacks (quite small, in my view) from those recent highs which, some suggest, may be the peak for this cycle. This in turn could be the forerunner of an economic slowdown and a market correction.
I concur that this U.S. economic recovery, as measured by the annual per cent changes in real GDP, is the second slowest since the 1961 recovery. That said, I do not see any areas of economic excess (auto sales and sub-prime lending perhaps being exceptions). As for the S&P 500, many have argued that its recent rise has mainly been due to the FAANG stocks (Facebook, Apple, Amazon, Google and Microsoft) and that many stocks in other areas have gone up less and/or are flat to down. In fact, they point out that the Advance/Decline index is somewhat sickly and that it is a better indicator of the market’s health. That is because the index is market-cap weighted while each stock in the A/D Line has an equal weight.
Aside from the foregoing, there are some other issues that markets will have to consider. Perhaps the current and future most impactful is the price of WTI/Brent oil. In the short term, increases in production from U.S. shale producers (short-term bottlenecks notwithstanding), Libya and Nigeria are the key things to watch. In the mid- to longer term, there are two key issues. The first is the appointment by King Salman (of Saudi Arabia) of his son Mohamed bin Salman as his successor. How that plays out is absolutely crucial as it could represent a break with tradition and Saudi oil strategy. For example, his son has been known to consider abandoning production cuts in favour of maximizing production and Saudi Arabia’s cash flow, which he could use to diversify the country away from oil. The current and potential future surplus has major implications for the U.S. consumer (positive) and the U.S. CPI. While energy is currently 7.2 per cent of the index, the monthly fluctuations can be dramatic and, if WTI/Brent remains under pressure, could for now put a lid on inflation. That in turn would take pressure off the U.S. bond yields which would be a positive for stocks, i.e. income and dividend stocks particularly. The negative would be that S&P 500 earnings would be negatively impacted as energy earnings could again suffer. However, their per cent of the index and reported profits is substantially lower than in the past.
The second issue is just how the current Saudi-led spat with Qatar turns out. The same can be said for the U.S.–Iran nuclear deal and how that might impact oil flows.
Much is being made of the negative impact of a flattening of the U.S. (and Canadian) bond yield curve, i.e. the narrowing of the yield spreads in the five-year maturities relative to the two-year, the 10-year relative to the two-year and finally the 30-year relative to the two-year. If that leads to an inverse yield curve, i.e. two-year yields higher than five-, 10- and 30-year yields, that could be quite negative. In the past, that has been the forerunner of a recession and stock market correction. In my view, the yield curve in the U.S. and Canada may continue to flatten, but we are a long way from an inverse (negative) yield curve.
As for geopolitics, the world continues to be a scary place. We can’t predict just where and when the next “incident” will come from, but we remain wary about what might happen and the possible impact on stock prices.
“What about stock prices?” Looking at what drove U.S. stock prices before the U.S. election, there were three factors: low interest rates, increasing reported earnings and finally, expanding PE ratios. Post the election there was a “Trump Bounce” relating to an expected corporate tax cut, a repatriation of foreign cash balances held by U.S. corporations and a reduction in stifling regulations. Surprisingly, as these expectations faded the U.S. markets did not retreat as one might have expected. One reason was continuing better-than-expected reported earnings. Another was and still is the increasing flow of funds into ETFs. While that may be a short-term positive catalyst for markets, in my view it is also potentially dangerous. That is because there is no judgment in when the inflows should be invested or the timing of outflows. Inflows have to be invested immediately. Sales would have to executed immediately, which could be quite negative for markets in a negative environment. That said, as of June 23, S&P 500 consensus 2017 and 2018 PERs ranged from 18.5 to 18.8 and 16.3 to 16.6, respectively. The post-2000 high was about 18.4 in 2003-04. So what is our stance? I remain positive even though I recognize the potential dangers that could impact markets. My opinion is based on the view that the recent pullbacks in various U.S. economic sectors are likely to be short-term and will continue to be volatile. As I have said many times, this economic recovery will be longer than in the past given the severity of the 2007-08 recession. I expect that will be reflected in the continuing growth in reported earnings.
06/23 close: $54.33; one-year target price: $56.25; % change: + 3.6; Yield: 1.30%; Target total one-year return: +4.90%.; Date and price of last purchase: 06/22/17 at $53.73; Brokers’ ratings: 15: 3/6/6/0/0
The basic macro attraction is that “water is the next oil.” Water’s profile will continue to increase given the rising temperatures around the world. XYL is socially aware and a responsible industry leader. It is increasingly focused on finding solutions to the more efficient use of water. As it has in the past, it will continue to look for acquisitions that make long-term sense.
TD BANK (TD.TO)
06/23 close $65.27; one-year target price: $71.30; % change: +9.2; Yield: 3.68%; Target total one-year return: +12.9%; Date and price of last purchase: 06/22/17 at $65.34; Brokers’ ratings: 17: 2/4/11/0/0
As defensive, income-oriented holdings, I think Canadian banks are ideal investments. Recent changes to the IFRS 9 impairment legislation and proposed Bail In legislation should not really hurt any bank. The three focuses are on a bank’s P&C business, the credit quality of loans and overall expense control. TD is an industry leader in all three areas. I expect future dividend growth to match long-term earnings growth of about five per cent plus a year.
INTER PIPELINE (IPL.TO)
06/23 close: $24.85; one-year target price: $30.90; % change: +24.4; Yield: 6.52%; Target total one-year return: +30.9%; Date and price of last purchase: 09/13/16 at $26.67; Brokers’ ratings: 13: 1/3/9/0/0
IPL is a very conservatively-run Western Canadian energy company with a major focus on shipments to and from the oil sands. The three other segments are processing natural gas liquids, transporting conventional oil and storing oil (in Europe). Sixty per cent of its cash flow has no commodity price or volume exposure; 30 per cent has no commodity price exposure but some volume risk while 10 per cent has both. Later this summer it will make a FID on its propane dehydration (PDH) and its polypropylene (PP) projects. They could represent the next growth phase for the company. Finally, I expect the dividend is secure and expect modest future growth.
PAST PICKS: JUNE 27, 2016
- Then: $115.89
- Now: $122.77
- Return: +5.93%
- TR: +9.95%
HOME DEPOT (HD.N)
- Then: $124.67
- Now: $151.42
- Return: +21.45%
- TR: +24.19%
ROYAL BANK OF CANADA (RY.TO)
- Then: $75.20
- Now: $93.99
- Return: +24.98%
- TR: +29.82%
TOTAL RETURN AVERAGE: +21.32%