Ryan Bushell, president of Newhaven Asset Management
FOCUS: Large cap Canadian dividend stocks
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MARKET OUTLOOK

2018 has started on strong footing after another positive year in 2017. The S&P 500 has been up in each of the last nine years following the financial crisis with barely a material correction, while the Canadian market has lagged significantly in the last five years. Some of the major factors that have benefited the U.S. market during this run appear to be reversing course more recently, including strength in the U.S. dollar (down almost 10 per cent on a trade weighted basis last year), weak commodity prices (oil and base metals rallied significantly in 2017), low interest rates/inflation (poised to pick up, 3 Fed increases in 2017) and lagging global growth (China/Europe strengthening, emerging markets outperformance in 2017). It stands to reason that some of the flow of funds into the U.S. market over the past five years that have taken the S&P 500 to a significant valuation premium (largely owing to the technology sector) are poised to reverse course and find opportunities elsewhere. 

The big question for 2018 in my mind is what happens with interest rates. 2017 was the first year with multiple U.S. Federal Reserve interest rate increases in over a decade. However, longer-term benchmark yields were broadly unchanged year over year. I am looking for 10-year interest rates to perk up toward or even through the three per cent level in the United States alongside a similar ~75 basis point move in short-term rates given that an economy accelerating at full employment with added fiscal stimulus should create an inflation response. The market has become bored (myself included) waiting for this to happen but it doesn’t mean it won’t occur.  

A move up in longer-term interest rates would be a healthy signal for the economy in the near-term and would likely trigger a significant sector rotation toward inflation proxies and markets whose currencies are positively correlated with such proxies (like Canada). If I am wrong and we continue to get short-term interest rate increases that invert the yield curve, it could spell trouble for the whole market sooner than later, but that would not be my base case scenario. 

Overall, I think 2018 is setting up fairly well for the Canadian market on a macro basis, so long as oil and housing do not suffer a significant setback — two admittedly large ifs. Regardless, collecting a ~4 per cent dividend yield in your portfolio, in my view, remains one of the best ways to participate moderately in the continued potential of this current market run while protecting downside, when the ultimate reckoning of one of the longest bull markets in history gets sorted out. 

We often said in the early part of this decade, “what if all this free money (monetary and fiscal stimulus) gets some confidence behind it?” I think we are seeing that now. I don’t think investors can afford to hold too much cash with short-term interest rates still below inflation. However they better be sure they understand, and are confident in, what they own. Be prepared to endure some volatility in the next year or two.

UPDATES

My new firm, Newhaven Asset Management Inc, is a high net worth investment counseling firm established in 2006 with a focus on sustainable dividend based investing. I joined the firm as president and an equity owner with the goal of providing high level service and investment advice to a select group of convicted long-term clients. 

TOP PICKS

ALTAGAS (ALA.TO)
Another market call appearance, another AltaGas recommendation. I know it may seem odd to some of the viewers to continue recommending a stock that has traded between $28 and $35 for the last two years while many other stocks and sectors have gone straight up, but these are often the best ways to generate sustainable returns over a full investment horizon of 20 years or more. AltaGas has a stable and growing dividend that is sustainable and continues to deliver critical infrastructure projects on time and on budget. Since February 2015 the stock is off nearly 30 per cent, while the dividend is up nearly 30 per cent and now yields over 7.5 per cent. I can’t make that font bold enough and that’s why I continue to own this stock as the largest position in my personal portfolio in a world where bitcoin, technology and marijuana stocks are all the rage. Last purchased at $28.75.

MANULIFE FINANCIAL (MFC.TO)
As mentioned earlier, I expect higher long-term interest rates in 2018, which is only the beginning of the positive story on Manulife. We also like the new CEO and the direction the company has headed over the past few years in terms of limiting/reorganizing long-term liabilities and simplifying the business. Manulife could free up some much needed capital if they sell the John Hancock division as has been rumoured, but will also get tax relief while they continue to hold it. Overall I like the 3.15 per cent dividend yield and expect a 10 per cent increase here in Q1 alongside all the other fundamentals mentioned above. Last purchased at $26.15.

NORTHLAND POWER (NPI.TO)
This company has an excellent track record of sourcing, developing and earning a return on renewable power projects in multiple jurisdictions. Most recently they just completed a large offshore wind power project in Europe and have another one nearing completion that spikes their free cash flow profile materially. The 10 per cent dividend increase at the end of 2017 was a sign of things to come and will likely start to be recognized by the markets in 2018 and beyond. Much of 2016 and 2017 was dogged by an ultimately “unsuccessful” strategic review which left the shareholder base somewhat directionless, and thus the stock traded in a narrow range for the entirety of last year. The stock yields over five per cent at current levels and has outsized dividend growth ahead likely combined with exciting new project announcements. We believe the key shareholder, Jim Temerty, is shrewd and held on to his interest in the company for a reason and we feel confident being aligned with his interests. Last purchased at $23.25.

PAST PICKS: FEBRUARY 14, 2017

CANADIAN NATURAL RESOURCES (CNQ.TO)
Obviously 2017 was a better year for the oil price than many imagined; however many oil and gas stocks didn’t fully participate. CNQ held its own in 2017 from a share price performance perspective while completing a transformational acquisition of Shell’s AOSP project. I think this is one company that any oil and gas investor should own for the long term. You will likely get a better entry point at some juncture this year; however on a long term basis this company is set to generate significant growth in free cash flow and dividends at a range of commodity prices. The company raised its dividend significantly in 2017 and I expect another material increase in Q1 2018.

• Then: $39.69
• Now: $46.51
• Return: 17.19%
• Total return: 20.25%

ALTAGAS (ALA.TO)

• Then: $31.24
• Now: $29.10
• Return: -6.85%
• Total return: -0.54%

ENERCARE (ECI.TO) 
We are pleased with the entry point we selected in Enercare below $19 which gives us a running yield of over five per cent on our cost basis for clients. There will continue to be some hiccups as they integrate the Service Experts business into their ecosystem so you may get opportunities to purchase it in the high teens again in 2018, but I would not be too picky. The stock still yields around 4.75 per cent at current levels and will see modest (three to five per cent) dividend growth while they spend upfront capital to expand the rental furnace/air conditioning (HVAC) business in the U.S. to levels comparable with their Canadian operations. Once that ramp up is completed (in the next few years) there will be a material spike in annuitized free cash flow that should pave the way to more material dividend increases resulting in share price upside.

• Then: $19.02
• Now: $19.92
• Return: 4.73%
• Total return: 8.88%

TOTAL RETURN AVERAGE: 9.53%