**July 22nd Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer Market
- JMRD Market Commentary
- JMRD Basket Corner
- Retirement Corner
- Reads of the Week
- Economic Calendar
- Earnings Reports
JMRD Market Commentary
What a year 2016 has been so far. After a very volatile first two months of the year where the major US and Canadian stock indices were down approximately 10% or more in late-January, the Canadian market is close to a one-year high and the Dow Jones Industrial Average and S&P 500 indices are hitting new all-time highs. Seldom have we seen these extreme moves in such a short period of time. That said, recent client conversations have brought some common themes to light and we feel that now is a good time to review a few of them.
In no particular order, the themes that clients are asking about include:
- Am I still on track with my financial plan?
- Asset allocation and diversification. Do I own the right assets?
- Why are interest rates so low around the world?
- What effect has the strength in the Canadian dollar had on my portfolio?
- What is next for the markets?
Well, these are all excellent questions with some more difficult to answer than others. There is no single response that applies to everyone. Rather, the conversations tend to be very client specific. Below, all these questions are addressed and our objective is to move this dialog forward.
So, here goes:
Am I still on track with my financial plan?
The objectives of the JMRD Wealth Management Team have not changed and are discussed with all clients:
- Investors must continue to focus on their individual risk / reward profile.
- Protecting portfolio values to the downside and minimizing risk continues to be our primary objective for 2016 and beyond. We are constantly trying to avoid the ‘big mistake’, as we like to say in our investment committee meetings.
- Investors must have an investment plan and stick to that plan.
- Review your Investment Policy Statement (IPS) and ensure your asset allocation is up to date and appropriate. Please feel free to talk to us for clarification on this very important point.
- The new ‘Annual Financial Planning Review’ and ‘Two Year Client Check-Up’ we launched in 2014 will provide timely opportunities for clients to review or implement plans.
- Focus on income and get paid to wait: for cash flow, invest in dividend and interest paying securities.
Though conservative by definition, these top three objectives allow us to position portfolios conservatively, but this is not a call to reduce equity exposure.
In summary, there is no quick response to this question. Confirming that you are still on track requires a conversation and a review of your plan. The main question when reviewing your plan is this: has anything changed?
Asset allocation and Diversification
This is a big topic being discussed and we have attached two excellent pieces below that provide thoughtful comments on both.
We are big fans of both Josh Brown and Ben Carlson and welcome your feedback on these articles.
JMRD uses asset allocation for all clients as part of risk management and portfolio development. The natural extension of proper asset allocation is a well-diversified portfolio. The difficulty with diversification in recent years (short term) is the divergence of returns over the various asset classes available to us. Usually, the more equity that is in your portfolio, the more risky it is because stocks do not have any guarantees and will fluctuate in value. What we are seeing more of is tremendous volatility created by the following:
- Currency fluctuations (more below).
- Geo-political events (think Brexit).
- Generationally low yields in bonds and other fixed income investments with a trend to negative interest rates.
- Split second access to information that investors around the world act upon, sometimes to extremes.
Something else that needs to be reviewed on a regular basis is the chart below that compares the returns of each asset class over the years. As you can see, there isn’t one asset class that outperforms the others EVERY year. And not all asset classes move in the same direction. It’s random from year to year and that is why asset allocation is a main premise of investing.
Why are interest rates so low?
- The bank rate in Canada is 50 basis points or ½ of 1%.
- The Fed Funds Rate in the US is 25 basis points or ¼ of 1%.
- The five year Government of Canada Bond yield is 0.63% (that’s right…if you lend money to our Federal Government, you will get 0.63% per year for five years).
- The ten year US Government bond yield is 1.56%.
- One to five GIC rates range from 1.45% to 2.00%.
The trend to lower rates is a result of global economic growth slowing. This is a bit confusing because the US economy seems to be in relatively good shape. Q2 GDP is expected to be at 2.4%, wages are growing, the ISM non-manufacturing number (a reading of the health of the US service sector) just came in at 56.5 and jobless claims are at 40 year lows. Granted, there are some worrisome trends out there as well, but the broader picture doesn’t seem to mesh with the current low interest rate environment we’re in because at this stage in past economic cycles interest rates are usually higher than they are now.
Further to our analysis of low interest rates, if we step back and look at the global picture then it all starts to make a bit more sense. The US bond market is stuck in a global vortex of historically low rates. Thanks to weak growth in China, Europe and Japan, global central banks have cut rates in an effort to spur growth. This leaves savers earning virtually nothing on their cash in a weak environment in which longer rates also don’t yield much. And on a relative basis, the USA looks like a high yield safe haven because its rates are ‘higher’ than most other global interest rates.
What effect has the strength in the Canadian dollar had on my portfolio?
Below is a chart of the Canadian dollar versus the US dollar for 2016. As you can see, the US dollar peaked at $1.4695 earlier in the year before hitting a low of $1.2462 on May 3rd. Currently the Canadian dollar is trading at $1.3060, which is approximately 6% lower versus the CDN dollar for the year.
One significant observation is this: If you own USD denominated investments and if you convert these investments to CDN dollars they are down 6% when factoring in the weakness of the US dollar so far this year.
NBF’s Economics and Strategy forecast for the balance of the year is for the USD to strengthen to $1.35 by year end, but it is expected to weaken to $1.31 by Q2 2017.
The price of oil over the next year will undoubtedly impact the direction of the USD/CAD. One more chart of interest is when we overlay the price of oil on the currency chart above. The correlation between oil price changes and the currency changes are profound; as oil prices (red line) go up, the USD/CAD (yellow line) goes down i.e. the CAD strengthens with oil.
What is next for the markets?
This is the burning question on everybody’s mind. Can the market go higher considering it’s already had large move from the post-BREXIT lows? Earnings season has just begun in the US and thus far it has been encouraging. It can also be observed that the market continues to trudge higher in the face of bad news i.e. BREXIT, terrorist attacks in Paris and Nice, attempted coup in Turkey. When the market climbs a ‘wall of worry’ like it has in the recent past, the momentum can continue for longer than most expect. The market still faces sluggish global economic growth, prospects of a Trump presidency and an ongoing terrorist threat so volatility can and will creep back into the markets at some point in the near future. Regardless of what the market does in the next few weeks or months, we should focus on what we are able to control and that is sticking with a plan and ensuring adequate diversification by geography and by asset class.
We will close off this section with an article from Forbes Magazine which echoes a lot our sentiments that you read above.
JMRD Basket Corner
Brookfield Asset Management (BAM’a) – “Brookfield Asset management to join forces for stressed asset fund” (Bloomberg)
Canadian National Resources (CNQ) – “CNRL sneaks to top Canadian natural gas spot with shopping spree” (Globe and Mail)
Keyera (KEY) – Keyera announced on July 8 that it has reached an agreement with Bellatrix Exploration to acquire an additional 35% ownership interest in the fully utilized 110 mmcf/d Alder Flats deep cut gas plant and associated gathering pipelines for total consideration of $112.5 mln. The acquisition is underpinned by a 10-year take-or-pay commitment with Bellatrix (~80.5 mmcf/d of total capacity of 230 mmcf/d, including phase 2), an area dedication agreement and includes prepayment of 35% towards the ~$100 million, 120 mmcf/d Alder Flats phase 2 project (under construction; online H1 2018). Near the end of the final year of the agreement, BXE will have the option of reacquiring a 5% interest in the Alder Flats facility for $8 million. Closing of the deal is expected in August, with BXE continuing to be a 25% owner and operator of the facilities.
Northland Power (NPI) – Power Producer Northland Power announced in July 12 that it plans to review strategic alternatives to bolster growth, shareholder value and its “ability to capitalize on a growing pipeline of clean energy infrastructure development opportunities.” Analysts estimate that the company could receive $26.00 – $27.00 should the company find a buyer.
All Cap Basket
CCL Industries (CCL.b) – “How CCL Industries quietly became the world’s largest label-maker” Through a skilled acquisition and consolidation strategy, this Toronto Company is rolling up the label and packaging business. (Canadian Business)
New Flyer Industries – A recent update on the company attached following an analyst tour to New Flyer’s Motor Coach Industries’ (MCI) Winnipeg facility. (Update attached)
Premium Brands (PBH) – Earlier this month, Premium Brands holdings announced plans to construct their 5th and largest sandwich plant, scheduled to open in the Second Quarter of 2017 at a cost of US$29 million. (C $37.5 million). Once the 212,000 square foot Phoenix based plant is up and running, it should represent 34.8% of total sandwich capacity filling a geographic void underserved by Columbus (180,000 SF), Reno (160,000 SF), Edmonton and Montreal. Since 2011 we estimate that the sandwich business has been growing at a 46% CAGR. (Full report attached)
U.S. Growth Basket
Lockheed Martin (LMT) – Lockheed Martin further lifted its forecast for the year as the military contractor logged higher F-35 jet fighter deliveries and benefited from sales in its recently acquired Sikorsky helicopter unit. Maryland-based Lockheed, the world’s largest military contractor by revenue, has been working to reshape its business as it looks to focus on more profitable work building military jets, helicopters and missiles. Last year Lockheed bought helicopter maker Sikorsky Corp. for $9 billion, and it said earlier this year that it would divest its big government information-technology unit and merge it with Leidos Holdings Inc., a deal the company said Tuesday is on track to close in the third quarter.
Altria Group (MO) – “Philip Morris new technology makes a case for a reunion with Altria” (Globe and Mail)
Prologis Inc. (PLD) – Prologis said earnings nearly doubled in its latest quarter as the owner of warehouses and distribution centers continues to benefit from companies’ demand for storage space as they shift to e-commerce. “Demand remains ahead of supply in both the U.S. and Europe, leading to all-time low vacancy rates,” said Chief Executive Hamid Moghadam. As consumers are increasingly shopping online, opting to make purchases on sites like Amazon.com instead of at physical locations, companies still need to adapt their supply chain strategies, Mr. Moghadam said. Occupancy across Prologis sites was 96.1% during the quarter, up from 95.4% a year earlier, and revenue from rent jumped 18%. In all, the company reported a profit of $277.1 million, or 52 cents a share, up from $141.9 million, or 27 cents, a year earlier. Core funds from operations increased to 60 cents a share from 52 cents. Revenue rose 18% to $546.1 million. Analysts projected 59 cents a share in adjusted funds from operations on $564.9 million in sales, according to Thomson Reuters.
United Health (UNH) – UnitedHealth on Tuesday posted a strong earnings beat as revenue continued to surge in its pharmacy-services business, and the biggest U.S. health insurer lifted the low end of its profit guidance for the year. The Minnetonka, Minn., company now expects adjusted earnings for the year of about $7.80 to $7.95 a share, compared with its previous forecast — raised in April — for $7.75 to $7.95 a share.
Visa (V) – Visa reported a profit of $412 million, or 17 cents per Class A share, for its fiscal third quarter ended June 30, down from $1.7 billion, or 69 cents per Class A share, a year earlier. Excluding one-time items related to its acquisition of Visa Europe Ltd., earnings were 69 cents a share. Revenue rose 3.2% to $3.63 billion, up 6% on a constant-dollar basis, driven by improved payments volume. Analysts polled by Thomson Reuters projected earnings of 66 cents a share on revenue of $3.65 billion.
- “Here’s Where Your Country Ranks on Retirement” (Bloomberg)
- “Growing older has an array of hidden costs” (Globe and Mail)
Reads of the Week
- “The Future of Big Oil? At Shell, It’s Not Oil” (Bloomberg)
- “Separating Decisions” (The Irrelevant Investor)
- “Peculiar Stock Leadership in 2016” (The Investor’s Field Guide)
- “Mark Carney has seeded a revolution by embracing fintech” (Globe and Mail)
- “Mater Plan, Part Deux” (Elon Musk – Tesla)
- “‘Mom, I’m bored!’ Here are 15 ways to keep the kids occupied this summer without breaking the bank” (Financial Post)
Monday July 25th – None
Tuesday July 26th – US Service PMI Index, US Consumer Confidence, US New Home Sales
Wednesday July 27th – US Durable Goods Orders, US Pending Home Sales, US FOMC (FED) Policy Statement
Thursday July 28th – US Initial Jobless Claims
Friday July 29th – Canada GDP, US GDP, US Chicago ISM Index
Monday July 25th – Capital Power, PrairieSky, Sherritt Int’l
Tuesday July 26th – DH Corp, Norbord, Restaurant Brands, Colliers Int’l, 3M, Apple, McDonald’s, Verizon
Wednesday July 27th – Barrick Gold, Exco Technologies, Constellation Software, First Service, Goldcorp, CGI Group, Gildan, Intact Financial, Loblaw Cos, Open Text, Suncor, Altria Group, Boeing, Coca-Cola, Facebook
Thursday July 28th – Baytex Energy, Cameco, Cenovus, Fairfax, Maple Leaf Foods, Nevsun Resources, Potash, Teck, Thomson Reuters, TransCanada, Uni-Select, Alphabet Inc, Amazon.com, Vantiv
Friday July 29th – Arc Resources, Enbridge, Enbridge Income Fund Holdings, Transalta Renewables, Imperial Oil, Quebecor, Riocan REIT, Secure Energy Services, Superior Plus, Exxon Mobil, Fortis, UPS
Have a good weekend!