Terry Shaunessy's Top Picks: December 16, 2016

Terry Shaunessy, president and portfolio manager at Shaunessy Investment Counsel
FOCUS: Exchange Traded Funds
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MARKET OUTLOOK
With the Presidential handoff in January 2017, U.S. economic policy will shift from a defensive, post-financial crisis mentality characterized by extreme interest rate management, anemic capital spending and fragile consumer/business confidence, to a “pro-growth” agenda led by significant corporate tax cuts, a rollback of regulatory burden, and a meaningful public works program. With the Republican Party firmly in control of both chambers of Congress, there is optimism that the Trump Administration will be able to enact most of its proposed stimulative policies thereby boosting overall domestic GDP beyond the recent 1.5 per cent to 2 per cent experience. 

This is very good news for global equity markets. We maintain an overweight position in US equities anchored by the S&P 500 but with a tilt to the U.S. financial sector and U.S. mid-caps. We believe that a steepening yield curve will help bank net interest margins while a pickup in housing will drive personal loan and mortgage growth. Corporate lending is also expected to be a positive for US banks based on the prospects for inventory and capital investment. Furthermore, regulatory relief may boost investor confidence beyond the attractive fundamentals in the financial sector. 

The U.S Mid Cap Index (median market cap US$3.7 billion) focuses more on the domestic U.S. economy as compared to the S&P 500. According to FactSet, mid cap index earnings are forecast to rise by 11 per cent to 12 per cent in each of the next two years based on a 5 per cent increase in sales for both. In our view, consensus sales forecasts are far too conservative and profits over the next 24 months could easily beat expectations given the high degree of operating leverage within these companies. 

We believe bond yields will continue to rise, therefore, allocations to this asset class will remain at minimums with an emphasis on credit (investment grade bonds and preferred shares), risk (US high yield) and shorter duration. The U.S. dollar will continue to dominate all major currencies.

Canada should benefit from a healthier U.S. economy but much of the expected improvement in resource profits, especially energy (21 per cent of the TSX Composite), seems to have already been discounted in the 2016 TSX rally. Unless there is some “new news” (e.g. crude oil reaches US$60+) we expect a sideways trade in the 2017 Canadian equity market. We also believe that a slowdown in mortgage credit and a rise in Canadian interest rates will constrain earnings growth within financial services (33 percent of the TSX). Our favourite sector is materials (11 per cent of the TSX) as we look for a rebound in gold mining shares as investors recognize improved operations and healthier balance sheets, anticipate M&A activity and begin to focus on the prospects for inflation later in the cycle.  The boost in U.S. interest rates should weigh on the Canadian dollar. Our 2017 expected range is 70 to 75 cents. We think that the recent strength following the OPEC-induced crude price rally may be short covering in the Canadian dollar rather than a renewed interest in Canada.

Finally, international developed markets, as defined by the MSCI EAFE Index, hold the most potential for upside surprise in 2017. Political and economic risks are already well known and discounted in the low P/E ratios of the EAFE Index when compared to North American counterparts. Since much of the EAFE Index is comprised of global cyclical companies, we see profits benefitting from accelerating U.S. growth and a high U.S. dollar.          

TOP PICKS

iSHARES S&P MID-CAP INDEX ETF (XMC.TO) $16.95
With a median market cap of $3.7 billion, this index tends to focus more on domestic US firms than S&P 500 Consensus EPS is forecast to rise by 11-12 per cent over the next two years but we think that this number may be low as sales are only forecast to rise by 5 per cent. Major industry sectors are Technology 17 per cent, Financials 17 per cent and Industrials 15 per cent. 

iSHARES S&P/TSX CAPPED MATERIALS INDEX (XMA.TO) $12.75
We are positive on the prospects for gold and gold stocks in 2017. In addition, this sector ETF gives investors exposure to deep cyclical industries (chemical, base metals and forest products) that will benefit from anticipated accelerating global GDP growth led by the U.S.

iSHARES CORE MSCI EAFE IMI INDEX (XEF.TO) $26.33 
Big Cap international stocks may be the most interesting asset class in 2017. Investor expectations have been very low and as a consequence, EAFE index metrics are very attractive. International indexes tend to be weighted toward mega cap global sectors: industrials, consumer discretionary and staples. The Financial sector is in recovery as are energy and metals .The soaring U.S. dollar will boost the local currency profits of these stocks. 

PAST PICKS  SEPTEMBER 23, 2015

BMO EQUAL WEIGHT U.S. BANK INDEX ETF (ZBK.TO)
This ETF is still a core holding within our Family and Institutional accounts. We have a 5 per cent allocation target and recent strength will cause us to re-balance taxable accounts in January 2017. Non- taxable accounts were re-balanced on Monday.

• Then: $18.08
• Now: $24.00
• Return: +32.74%
• TR: +35.44%

HORIZONS ACTIVE PREFERRED SHARES ETF (HPR.TO)
HPR remains a core holding within both Family and Institutional accounts. Current yield of 4.3 per cent, compares favourably to Canadian corporate bond index yield of 3.1 per cent with essentially the same credit risk. Financials represent 43% of Canadian corporate bonds and 50 per cent of HPR.

• Then: $8.41
• Now: $8.61
• Return: +2.37%
• TR: +8.53%

iSHARES RUSSELL 2000 INDEX (IWM.US)
I prefer mid cap index XMC to IWM at current levels. IWM sold March 31 2016 $110.63

• Then: $113.42
• Now: $135.91
• Return: +19.82%
• TR: +22.66%

TOTAL RETURN AVERAGE +22.21%

WEBSITE www.shaunessy.com