JMRD Market Observer for October 3, 2014 – The Diversified Income and Growth (DIG) Basket: Third Quarter Update‏

October 6, 2014

**October 3rd Issue of The JMRD Market Observer**

 In This Week’s Market Observer…

  • JMRD Strategy Note
  • The Diversified Income and Growth (DIG) Basket:  Third Quarter Update
  • Asset Allocation Strategy – October 2014
  • NBF Monthly Equity Monitor – October 2014
  • JMRD Basket Corner
  • National Bank invests $1 million in inspiring youth-oriented initiatives
  • Retirement Corner
  • Week at a Glance
  • Reads of the week
  • Economic Calendar
  • Earnings Reports

JMRD Strategy Note

 This week, market volatility continued and share prices continued to slide as we started October and the final quarter of the year.  While we have heard many reasons for the weakness, no one knows exactly what the main cause is.  September is historically the weakest month of the year and so far that has been the case in 2014. The TSX is now down 5.5 from its recent all-time high while the S&P is down 2.9% from all-time highs (both at the time of writing).   However, there are many equities down more than the indexes. That said, we would also point out that many companies continue to have healthy returns this year, even with the recent selloff.  Markets always fluctuate and it appears we may finally be having the correction that many investors have anticipated for a while.  Does that mean one should make wholesale changes just because of share price changes?  The short answer is no.  Warren Buffett was on CNBC this week and commented that he hopes the companies he was buying on Wednesday are even LOWER next week.  It may seem counter-intuitive but the man most referred to as the worlds greatest investor rightly looks at lower prices as an opportunity to add to his core holdings at ‘better prices’.  Many investments he will hold for years so he does not concern himself too much with the market fluctuations, whether positive or negative.

This portfolio approach is what we strongly encourage. An investor should always have an investment policy statement and rebalance at regular intervals, regardless of market movements in the short term.  It is very difficult to time the market and often investors will do so at the wrong times. Rebalancing at regular intervals takes the emotion out of portfolio changes and improves the probability for long term investment success.

The Diversified Income & Growth (DIG) Basket: Third quarter Update

 Some big news for DIG Basket holders as the year to date return to the end of September is 13.085%.

An even more impressive number is the 1 year return (October 1st 2013 to the end of September 2014) of 23.18% for DIG! The TSX Composite Total Return Index had a total return of 19.75% for the same 12-month period.

As you can see, the DIG Basket has performed well in 2014 and we feel it is positioned extremely well for the balance of the year.  A pullback in September and now early October may be presenting an opportunity to add to holdings.

 Before getting into specifics, we wanted to point out some milestones for the Basket as of the end of September:

  • Total assets exceeded $62,500,000 for the first time
  • Number of holders hit a new record of 558

 For new clients and for those not familiar with DIG Basket, we provide some historical returns:

  • 2009 return of 41.51% versus the TSX Total Return of 35.05%.
  • 2010 return of 17.27% versus the TSX Total Return of 17.61%.
  • 2011 return of 6.35% versus the TSX Total Return of -8.71%.
  • 2012 return of 8.61% versus the TSX Total Return of 7.19%.
  • 2013 return of 16.33% versus TSX Total Return of 12.99%.

 Compound returns have been very good as well.  Below are results as of the end of September 31, 2014:

  • 3  year compounded average return of 14.52%, versus the TSX Total Return of 12.07%
  • 4  year compounded average return of 13.28%, versus the TSX Total Return of 7.94%
  • 5  year compounded average return of 13.78%, versus the TSX Total Return of 8.67%

We also wanted to highlight the risk-adjusted returns of the DIG Basket versus the TSX Total Return Index and the S&P 500 since January 2009.  Risk adjusted return is an important concept that refines an investment’s return by measuring how much risk is involved in achieving that return.  An ideal situation is when an investment has a lower standard deviation (volatility) but a higher return than what it is being compared to.  As you can see from the attachment, the DIG Basket achieved a higher rate of return than both indices with a lower standard deviation versus the TSX Total Return Index (its true benchmark) and a similar standard deviation to the S&P 500.

DIG Risk Return

Below is a snapshot of the current holdings.  The current annual cash flow is $594 for a yield of 3.53%.  The yield is lower than usual due to two factors.  The first factor is that the underlying securities have increased in value which results in a lower yield.  The second factor is the 6% cash weighting that is currently in the DIG Basket, which we will deploy when an opportunity arises.  We lowered the cash allocation to 6% this week after adding to our position in CP Rail at $220.  The stock is now trading at $242.

DIG

We consider the DIG Basket a top pick for clients seeking income and growth and feel it is very appropriate for a portion of a client’s equity weighting.  The current value of one DIG Basket is approximately $16,900 making the minimum initial position approximately $34,000, which is 2 Baskets.  This amount will continuously change as the prices of the DIG Basket components do fluctuate.  Subsequent purchases can be made in one Basket increments.

 Asset Allocation Strategy – October 2014

 Market review

Volatility picked up in September as the uncertainty surrounding the timing of the first rate hike in the United States, coupled with an economic slowdown in Europe and certain emerging markets, the war against the Islamic state, the rise in the USD and student protests in Hong-Kong, prompted markets to pullback from new record highs set earlier in the month. The S&P 500 outperformed most of its peers with a drop of only 1.4% in September, thanks to its lower beta. The TSX and EAFE index both lost approximately 4%, while the worst performing region was emerging markets, with a decline of 7.4%. The drop in energy and materials prices caused by the near 3% rise in the USD during the month hurt Canadian small cap stocks, which fell more than 9%. Fixed income securities only offered a relatively small offset to the equity pullback, since the bond market was stuck between Fed hawkishness and increased volatility. Cash was king in September, particularly when held in U.S. dollar.

Asset allocation strategy

  • Equities: In the short term, we favor a prudent approach. Based on recent episodes the stock market pullback looks stretched, but October is famous for violent corrections that seem to appear out of nowhere. In the longer term, however, stocks continue to offer the best expected returns. We are maintaining our asset allocation weightings over the 12 to 18-month horizon. We recommend switching to large cap equities and maintaining a cautious mix of defensive high yielders and IT stocks. Europe is lagging and should benefit from a weaker euro as well as the probability of more easing on the part of the European Central bank (ECB).
  • Fixed income: Nominal yields should stabilize around current levels. With no recession in sight, high yield spreads are becoming attractive.
  • Currencies: Due to diverging monetary policies in the Eurozone and the United States, the euro should continue to weaken against the greenback. The long-term trend for the loonie is still downward.

 Asset Allocation Strategy

NBFM Monthly Equity Monitor – October 2014

  • Global equities, after hitting an all-time high in mid-September, are now struggling to maintain their momentum. At this writing it is uncertain whether the MSCI AC index will end the month with a ninth straight quarterly gain. The last time the global equity index broke below its 200-day moving average was in 2012.
  • In our view, the USD could be on the verge of a secular uptrend, as U.S. economic fundamentals continue to improve faster than those of its main trading partners: the U.S. Federal Reserve is guiding towards rate hikes at a time when the euro zone and Japan are looking the other way; the U.S. budget deficit is under better control; and surging U.S. energy production is improving the country’s trade balance. We think the greenback has considerable upside.
  • For the first time since 1994, the Fed could embark on a tightening phase while the USD is appreciating. History suggests that if our forecast is on the mark and the Fed begins tightening in June 2015, the effect on equities need not be a bloodbath. In the eight months preceding the first rate rise after the recession of the early 1990s, North American markets delivered positive returns.
  • Our asset allocation is unchanged this month. We remain comfortable with our recommendation to overweight equities relative to our benchmark while slightly underweighting fixed income products. Our year-end targets are reduced to 15,600 for the S&P/TSX (from 16,200) and to 2,070 for the S&P 500 (from 2,085). We have not altered our sector rotation this month.

Equity Monitor October

JMRD Basket Corner

 DIG Basket

 Manulife (MFC) – Manulife closed the financing last week to fund the purchase of Standard Life plc’s Canadian operations. On Sept. 3, 2014, MFC announced an agreement to acquire Standard Life Canada (SLC) for Cdn$4 billion in cash. In connection with the transaction, MFC issued Cdn$1.76 billion in subscription receipts along with a concurrent private placement of Cdn$500 million. MFC will fund the remaining amount through internal resources. The acquisition enhances MFC’s Canadian platform as the addition of SLC will double MFC’s market share in the Canadian group retirement business, while also strengthening the insurer’s group benefits and retail wealth management platforms in Canada.

CP Rail (CP) plans to more than double profit in four years as Chief Executive Officer Hunter Harrison seeks to improve efficiency by running longer, faster trains at Canada’s second-largest railroad. http://bloom.bg/1vy3Mjp

All-Cap Basket

Alimentation Couche-Tard (ATD.b)“Couche-Tard Rallying as Investors See Acquisition Growth”: Alimentation Couche-Tard is outperforming other retailers as investors wager the Canadian convenience-store operator is gearing up for more acquisitions after absorbing its latest billion-dollar purchase. http://bloom.bg/1vbgWkZ

U.S. Basket

Dow Chemical (DOW) – “Dow Says It Will Sell More Businesses”

Nike (NKE)  – “Nike Should Really Send a Thank You Card to Adidas” 

National Bank invests $1 million in inspiring youth-oriented initiatives

Sep 26 2014

National Bank is kicking off the second edition of its One for Youth program and will invest $1 million in 2014 to support youth-oriented projects (ages 0-25), across Canada. From September 29 to October 17, 2014, non-profit organizations (NPOs), elementary schools and high schools will be able to apply for up to $15,000 in financial support by submitting inspiring youth initiatives that are centred on health and wellness; education; and inspiring and empowering young people. This is over and above the involvement of National Bank employees who may also invest their time and expertise to make the selected initiatives a success.

We take great pride in the thought that our support can help youth-oriented projects get a solid footing. Young people all across Canada have big dreams and carry with them the promise of an even better society. At National Bank, we feel it is our duty to help them develop to their full potential and be a partner in their success,” underscored Karen Leggett, Executive Vice-President – Marketing and Corporate Strategy.

Over the next few months, 12 One for Youth regional committees, made up of National Bank executives, community leaders and a young person under the age of 25 will be busy reviewing a great many inspiring applications. From coast to coast, these committees will select local and regional youth initiatives that could benefit from financial support or volunteers, based on the selection and eligibility criteria of the One for Youth program.

NPOs and schools must send in their youth initiatives to the One for Youth regional committees by completing the application form available online at nbc.ca/committees. For inspiration, take a look at the video on the committee’s top choice from the first edition at National Bank YouTube channel.

Retirement Corner

  1. “The newly rich: How your world changes when downsizing creates a windfall” (Financial Post)
  2. “Why older seniors should rent instead of buy (Financial Post) 

 Week at a Glance

Week At A Glance

Reads of the Week

  • “National Bank Benefits by Taking Out the ‘Garbage’” (Bloomberg) Credigy Ltd., the distressed-debt firm that got its start chasing delinquent credit-card borrowers in the U.S., has moved beyond collecting on bad loans to become one of National Bank of Canada’s fastest-growing profit contributors

Economic Reports

Monday October 6th – Canadian Ivey Purchasing Managers Index

Tuesday October 7th – Canadian Building Permits, Fed Releases Minutes from Sept 16-17 FOMC meeting

Wednesday October 8th – Canadian Housing Starts,

Thursday October 9th– Canadian New Housing Price Index, U.S. Initial Jobless Claims, Wholesale Inventories, Wholesale Trade Sales

Friday October 10th– Canadian Unemployment Rate, Canadian Net Change in Employment, U.S. Monthly Budget Statement, U.S. Import Price Index

 Earnings Reports

Monday October 6th – None

Tuesday October 7th – None

Wednesday October 8th – Alcoa, Costco, Jean Coutu Group

Thursday October 9th– None

Friday October 10th– None

Categorised in: