JMRD Market Observer for April 13th, 2017 – JMRD U.S. Growth Basket Q1 Update

April 13, 2017

In This Week’s JMRD Market Observer

 

 

  • JMRD U.S. Growth Basket Q1 Update

  • BoC Policy Monitor – Bank of Canada remains cautious amidst “significant uncertainties”

  • Canadian banks – Thematic research: Efficiency improvement: the road ahead and who we believe is best positioned to deliver

  • Retirement Corner

  • Reads of the week

  • Economic Calendar

  • Earnings Reports

     

 

JMRD U.S. Growth Basket Q4 Update:

 

It is that time of the year where we provide a quarterly update on the JMRD Baskets.  This week we will review the JMRD US Growth Basket, which posted a return of 10.19% for the first quarter.

 

Before we get into the Q1 US Growth Basket commentary, let’s first review the various returns of different investment vehicles for the first quarter of 2017, shown in the chart below.

 

 

As you can see from above, the first quarter of 2017 ended with positive returns for most major global markets.  Volatility was rather subdued in Q1 as well.  The VIX Index (a measure of market volatility) was stuck in a range between 11 and 13 for the quarter, which is historically low.  It spiked above 15 in late March after news broke that Trump did not garner enough support to repeal the Obamacare bill.  Investors felt that Trump’s plans to lower taxes and to implement his infrastructure plan could also be delayed in similar fashion to the health care repeal attempt.  Equities sold off the next day but as has been the case in the recent months, the downturn was quite minor and short-lived and the market quickly recouped the losses.  To put the VIX range into perspective, leading up to the US election, when the market was choppy because the election polls seemed to be changing by the minute, the VIX index went from 13.5 in late October to its recent high of 23 on November 4th.  During the Brexit voting period, the VIX spiked from a low of 12.3 in mid-June to a high of 26 in early July.

 

Needless to say, the market has been in a relatively quiet period, which most often can and will change as the month’s progress.  Potential market moving events in the coming quarter include earnings season, which kicked off today with JP Morgan and Citigroup reporting.  The United States Federal Reserve will once again be convening to discuss the direction of US interest rates in mid-June.  The US FED has raised rates twice since December and further hikes seem imminent.  The French presidential election will be held in the next month, followed by the German election in September.  The market will be watching to see if these countries shift to more populist leaders, as was the case in the US. In the meantime, we continue to look for the companies showing the most strength in their respective sectors and won’t waiver from this process.

 

Turning to the JMRD US Growth Basket, as alluded to above, the first quarter was quite good as the basket returned 10.19%.  February was a particularly good month, with a +6.4% return.  In Q1, the benchmark S&P 500 Total Return Index posted a return of 6.07%.  Generally, all major US markets were in the green in Q1 but the NASDAQ (predominantly technology stocks) specifically was the better performer, posting a return of 9.8%.  The JMRD US Basket’s exposure to the technology sector was the main contributor to the outperformance.  Our position in Arista Networks (ANET) was up 36% in the first quarter.  This supplier of cloud networking solutions posted very strong earnings in mid-February and add in some analyst upgrades and the stock spiked higher.  Broadcom Ltd. (AVGO) a developer and supplier of semiconductor devices was up 24% as the whole sector gained on the expectation of higher global tech spending.  Applied Materials (AMAT) also had a strong move in the quarter, up 20%.  Facebook (FB) hit new highs in the quarter as well, posting a gain of 23%.  Non-tech names to get a boost were:  MSCI Inc., the provider of products and services to support institutional investors, up 23% after and solid quarter and because of takeover speculation and Vail Resorts, up 19% after it too posted solid quarterly numbers.  Steel Dynamics (STLD) and the US Regional Banking ETF (KRE) lagged in the quarter, after a very strong Q4 of 2016.  Both stocks were down about 1% in Q1.

 

It was a relatively quiet quarter for transactions.  We added to our position in the Regional Banking ETF on weakness.  We also initiated positions in Norfolk Southern (NSC) as we feel that the rail companies will benefit in a pro-growth economic environment, which is Trump’s intention.  We also initiated a position in HD Supply Holdings (HDS) an industrial distributor, for the same reasons we bought Norfolk Southern.  We exited our position in Transdigm Corp as it was the subject of an analyst report which questioned its accounting methods.  We didn’t want to be a part of this uncertainty.  We also sold the S&P 500 ETF, as this was a temporary holding until a new idea surfaced, which eventually became Norfolk Southern.  

 

How do we decide on which companies to buy in the JMRD US Growth Basket?

 

  • We use a proprietary relative strength technical analysis research that helps us to identify the stronger sectors to invest in. 
  • From there, we look to buy the strongest stocks in the best sectors. Stocks can be trading well but if they are in a strong sector, they can still be under performing.
  • Conversely, we look to avoid weak sectors as weak sectors and companies within those sectors can often stay weak for an extended period of time. 
  • Instead of trying to ‘guess’ when a stock might bottom, we look to identify the strongest companies that are performing well compared to their peers. 
  • For the U.S. Model we select among the top companies in the S&P 100 combined with Credit Suisse’s top picks.
  • The requirements are: Minimum $1B market capitalization, no more than two securities per sector and an initially equal weighted portfolio.

 

Which companies are currently held in the Basket?

 

  • We continue to include company updates on the holdings in our Market Observers so you can become more familiar with the individual positions.
  • You will find below a full snapshot of all holdings.

 

 

What are the parameters in terms of buying the new Basket?

 

  • The current value of the JMRD U.S. Growth Basket is approximately $27,200 (all figures in US dollars).
  • The initial minimum position is 2 Baskets, or approximately $54,400.
  • Subsequent purchases can be made in increments of a half Basket, or about $13,600.

 

Notes:

 

  • The minimum and subsequent purchase amounts are mandated by National Bank Financials Baskets department, not by JMRD.

 

 

BoC Policy Monitor – Bank of Canada remains cautious amidst “significant uncertainties”

 

As expected, the Bank of Canada left the overnight rate unchanged at 0.50% today. In light of the stronger than expected data, the central bank raised its 2017 growth forecast for Canada to 2.6%. However, it refused to ditch its dovish tendencies. While it acknowledged Canada’s economic growth has been better than expected, it attributed that partly to a temporary boost from the effects of the Canada Child Benefit and the resumption of spending in the oil and gas sector. The BoC said “while the recent rebound in GDP is encouraging, it is too early to conclude that the economy is on a sustainable growth path.” The central bank continues to bemoan exporters woes “in the face of ongoing competitiveness challenges”, soft hours worked, weak business investment, subdued wage growth and falling core inflation, the latter two reflecting “material excess capacity in the economy”. The BoC also says there are “significant uncertainties weighing on the outlook”.

 

The BoC raised its 2017 forecast for world growth by one tick to 3.3% (due to better outlook for the Eurozone, Japan and China), but lowered slightly its 2018 forecast to 3.4% (from 3.6%). For the U.S, the central bank trimmed 2017 by one tick to 2.1% while leaving 2018 unchanged at 2.3%.

 

For Canada, in addition to raising 2017 growth to 2.6%, the central bank lowered 2018 growth two ticks to 1.9%. This year’s upgrade was due to trade (lower imports than initially expected), housing and consumption spending, all of which more than offset downgrades to government and business investment. Real gross domestic income is expected to rise 3.6% this year, versus 2.3% in January’s estimate. The quarterly growth profile was changed to reflect a stronger-than-expected 2016Q4, but also a more bullish outlook for 2017. Indeed, the BoC’s forecasts put Q1 growth at a massive 3.8% annualized, while Q2 growth was estimated at a strong 2.5% (a bit surprising considering the Syncrude shutdown in April). Potential GDP growth was lowered to 1-1.6% for this year (because of weak investment) and to 1.1-1.7% for 2018. The BoC estimates the output gap at the end of 2017Q1 was 0.75% (the mid-point of the estimated range of 0.25%-1.25%). The central bank now expects slack to be eliminated in the first half of 2018, a bit sooner than what was estimated back in January. The BoC lowered its estimate of the neutral policy rate by 25 basis points to 2.50-3.50% to reflect lower potential GDP growth and “global factors”.

 

The Bank expects CPI inflation “to dip in the months ahead, as the temporary factors unwind, and then return to 2 per cent later in the projection horizon as the output gap closes”. But overall, the central bank’s inflation forecasts were largely unchanged, with the BoC still expecting inflation to be close to 2% in 2017 and in the two following years.

 

Bottom line: While acknowledging the improvement in economic conditions (which led to its upgrade to 2017 growth), the Bank of Canada refused to ditch its dovish tendencies, highlighting the negatives, i.e. exporters woes, “broad-based” softness in hours worked, weak business investment, subdued wage growth, and falling core inflation. The central bank accordingly continues to say there is “material excess capacity in the economy”. The BoC also says that its base case included “the estimated impact of prolonged and elevated trade policy uncertainty on trade and investment”. Although the Bank of Canada continues to point to its new measures of core inflation to justify its loose stance on monetary policy, it’s worth noting that its own analysis suggests they are lagging indicators (3 to 5 quarter lag to business cycle fluctuations). So, the soft annual core inflation rate may be reflecting the soft Canadian economy of late 2015/early 2016, not current conditions. In other words, the BoC may be looking at the rear view mirror and ignoring what’s ahead, namely a strengthening economy that’s pushing up prices and threatening financial stability (read house prices). Assuming downside risks do not materialize, e.g. worsening trade relations with the U.S., the Bank of Canada will eventually have to ditch its dovish language, something that could raise odds of a rate hike as early as this year.

 

See the full article.

 

 

Canadian banks – Thematic research: Efficiency improvement: the road ahead and who we believe is best positioned to deliver

 

Banks roaring ahead with efficiency gains. Efficiency improvement is one of the most important Canadian bank sector trends, a reflection of a challenging revenue growth environment and the impact of technology, among other factors. Between 2014 and 2016, the group recorded a cumulative $2.2 bln of restructuring charges aimed at improving efficiency (and enabling investment in technology). Recent results have been encouraging, with banks following up a strong 2016 (i.e., 70 bps of sector NIX ratio improvement) with an even stronger start to fiscal 2017 (i.e., 180 bps). In this report we evaluate how Canadian bank efficiency performance stacks up against banks in other regions and identify which banks we believe could deliver above-average efficiency improvement in the years ahead.

 

Benchmarking shows that Canadian banks still have a long road ahead. Despite impressive efficiency performance evident in recent results, comparisons with banks in other countries is not flattering for the Canadians. Since 2011, banks in Nordic countries improved their efficiency ratios by 770 bps while Australian banks pushed their NIX ratios down by 240 bps. In contrast, Canadian bank efficiency ratios have been relatively flat (i.e., no improvement). To be fair, the comparison needs to be taken within the context of a stronger revenue growth environment in Canada and some relevant “societal” differences, such as the cash-light Nordic banking system. However, the status quo is clearly not a viable option, and Canadian banks will need to make greater strides on the efficiency front than what we’ve seen in recent years.

 

Surprisingly, empirical evidence does not support the argument that scale translates into greater efficiency gains. With investors anticipating/demanding efficiency-driven EPS growth from the banks, it is important to assess which ones are best positioned to deliver. A common assumption is that banks with the most scale can more easily cut costs. However, empirical data in Canada and in other regions does not support this theory. Our approach to assess which banks have the most potential (or have greater urgency) to deliver efficiency gains weighs the following: (1) expected “yield” from recently announced restructuring initiatives; (2) sustainability of recent efficiency gains; and (3) distribution characteristics, with emphasis on branch productivity. Based on these criteria, we believe BNS and CM are best positioned to deliver on this key industry theme. However, CM’s acquisition of PVTB is a bit of a “wild card” in this regard, which leads us to favour BNS.

 

See the full article.

 

 

Retirement Corner

 

 

 

 

 

Reads of the Week

 

 

 

 

 

  • NBF Hot Charts: Home price inflation has become THE hot topic of discussion in Canada. Surging prices are no longer confined to greater Toronto and Vancouver. As today’s Hot Chart shows, we estimate that close to 55% of regional markets in Canada are reporting price inflation of at least 10%. This record proportion is very similar to that observed in the United States in 2005 at the peak of the market. Even if Canada continues to enjoy some of the best demographics in the OECD, home price inflation appears to be running ahead of fundamentals. When 55% of the market is on fire, the use of interest rates to cool things down is justifiable. The Bank of Canada must change its narrative and abandon its easing bias as soon as this week. See the full article.

 

 

 

 

 

Economic Reports

         

Monday April 17th – US Empire State Index

Tuesday April 18th – US Housing Starts, US Industrial Production

Wednesday April 19th – US Beige Book, US FOMC Policy Statement

Thursday April 20th – US Initial Jobless Claims

Friday April 21st – Canada CPI; US Existing Home Sales, US PMI Manufacturing

 

 

Earnings Reports

 

Monday April 17th – Lonestar, Netflix

Tuesday April 18th – Bank of America, Chicago Bridge and Iron, IBM,

Wednesday April 19th – Abbott Labs, American Express, CSX Corp, CP Rail, Unilever, Morgan Stanley, Mullen Group

Thursday April 20th – Aurora Spine, Danaher Corp, Keycorp, Visa, Verizon

Friday April 21st – GE, Honeywell, Schlumberger

 

 

Have a good long weekend!

 

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