**May 20th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer Market
- JMRD Supports Fort McMurray
- Canadian Bank Earnings Q2 Preview: The New Utilities
- FOMC Minutes – June rate hike a possibility
- JMRD Basket Corner
- Retirement Corner
- Week at a Glance
- Reads of the Week
- Economic Calendar
- Earnings Reports
JMRD participating in donation relief efforts for Fort McMurray, Alberta
With the recent scale of damage by forest fires in Fort McMurray, JMRD Wealth Management has decided to donate approximately one day’s revenue to the Red Cross campaign to assist victims. We have always been active in the community and believe that this is a very worthwhile relief effort for all Canadians.
We have watched with shock the general devastation and homes lost in the fires. The funds collected from donations will be used to give assistance to the victims by providing them with emergency food, clothing, personal services and other basic necessities to help them through this difficult time, while giving them courage to get back on their feet again.
National Bank was quick to donate corporately and with people we know being greatly affected by this fire, we wanted to help as well.
We will continue to watch the developments in Fort McMurray and hope things get better soon.
“Life Is Good”
We really don’t have it that bad
But we know some people do
We catch ourselves complaining sometimes
Feeling down and blue
What do we have to complain about
When we look around us and see
A roof over our heads, shirts on our backs
And some jingle in our jeans
Life is good
Even when things aren’t going
Quite the way we know they should
Knock on wood, life is good
Canadian Bank Earnings Preview Q2 f2016 – The New Utilities
Next week, Canadian banks will start to report Q2 results with Bank of Montreal on Wednesday followed by CIBC, Royal Bank of Canada and Toronto-Dominion Bank on Thursday. On May 31 Bank of Nova Scotia will report with National Bank of Canada winding up second quarter results for the big six Canadian banks on May 31. NBF’s bank and insurance analyst Peter Routledge has provided a preview note below.
Still waters run deep. While the title of this note may seem fairly innocuous, we think it connotes a useful framework for thinking about bank valuations. By this we mean that despite the earnings growth expected this quarter, there remain material market forces beneath the surface – conflicting in some instances – that will shape the banks’ near-to-medium term operating environment. Some forces will fuel sentiment and valuation in the sector (e.g., house prices) while others will fuel trepidation towards the sector (e.g., tightening net interest margins, the prospect of rising credit losses). We can see this in the volatility demonstrated in bank valuations since the beginning of the year.
Ultimately, we arrived at the conclusion that banks are essentially the new utilities – they provide investors with relatively safe dividends and a healthy yield but slow earnings growth. Several factors will restrain earnings growth. First, household credit growth remains uninspiring, rising 5.1% y/y through March which suggests moderate growth relative to expected nominal GDP growth of 2.4% for 2016. Second, the banks continue to face margin compression from a flattening yield curve which appears unlikely to abate. In fact, margin pressure is more likely to intensify via a potential future reduction in the Bank of Canada’s policy rate. Third, there remains the meaningful prospect that provisions for credit losses could rise from their current cyclical lows. Finally, those banks with international growth platforms have suffered growth rates similar to their Canadian platforms recently – the margin compression and slow asset growth affecting the banks’ Canadian operations applies equally outside our borders as well.
Given the 17% run-up in the Canadian Bank Index (STBANKX) since mid-February, the market has forgotten these concerns (along with some others risks we identify herein) … perhaps because these risks are not as threatening as we feared in February. To incorporate the possibility that we over-reacted to the February bout of market volatility, we have increased our price targets by 5% on average across the sector. This does not reflect a better earnings outlook – our EPS estimates for f2016 actually declined as a consequence of the pre-announced credit losses at NA and CWB – but rather it reflects a concession on our part to the market’s current bout of optimism towards the sector.
But we do not share fully in that optimism and, as a consequence, have held our price targets near today’s current prices. From this behavior, one can infer that we remain quite cautious towards the sector and we advise investors to adopt a similar level of caution. Our revised targets and rank order for the sector is as follows (owing to our affiliation, we do not rate NA):
- TD [Outperform; $58 PT from $55];
- BNS [Sector Perform; $64 PT from $60];
- BMO [Sector Perform; $82 PT from $78];
- RY [Sector Perform; $77 PT from $72];
- LB [Sector Perform; $50 PT from $48];
(Full report attached)
FOMC Minutes: June rate hike a possibility
The Fed just told us that a rate hike in June is a distinct possibility if incoming data is positive and consistent with a further strengthening in the labour market. Following the minutes, markets are pricing in a probability of just 30% or so for June hike (compared to 4% a week ago). Historically, the FOMC has rarely hiked when the probability priced by markets was that low. But there is still time for the Fed to guide markets towards its own view that a rate hike is desirable, e.g. Vice Chair Fisher and New York Fed President William Dudley are talking tomorrow, while Chair Yellen gives a speech on the 27th of May. However, with the Fed being data dependent, it will not be insensitive to weak data. Note that since the April meeting, we’ve had a significant slowdown in the labour market. If May’s non-farm payrolls (to be released before the June decision) are as disappointing as April’s report, a majority of voting members could be convinced that there is indeed a loss of economic momentum, justifying extending the pause to Q3 or later. That’s in line with our own view that weak profits have already begun to impact business investment, a development that is normally followed by weaker labour markets (chart). Why hike when job creation is already set to slow?
(Full note attached)
JMRD Basket Corner
Brookfield Asset Management (BAM.a) – Brookfield Asset Management Inc announced that it will affect the distribution of units in Brookfield Business Partners L.P. to holders of Brookfield’s Class A and B limited voting shares, which was first made public in October 2015. On June 20, 2016, shareholders of record as of June 2, 2016 will receive one BBP unit for every 50 Shares of Brookfield, or 0.02 BBP units for each Share. The dividend is currently estimated to be valued at $0.50 per Brookfield Share, or approximately $500 million in the aggregate. BBP has received conditional approval to list its units on the New York Stock Exchange and the Toronto Stock Exchange under the symbols “BBU” and “BBU.UN,” respectively.
Emera (EMA) – “Emera’s model: Customer value leads to shareholder value” The US$10.4 billion acquisition of TECO Energy will be transformative, vaulting the company into the ranks of the Top 20 regulated utilities in North America
Keyera (KEY) – Keyera announced a $300M offering of common shares and entered into agreements with a subsidiary of a large creditworthy multi-national producer for construction of a natural gas gathering and processing complex in the Wapiti area south of Grand Prairie, Alberta (the “Project”). Subject to final sanctioning, the Project is expected to include a sour gas processing plant with acid gas injection capabilities, condensate processing facilities, associated gathering systems and field compressor stations. Based on preliminary estimates, Keyera expects the total cost of the Project to be approximately $600 million, with operations of the first phase targeted to start up in mid-2019.
TransCanada (TRP) – TransCanada announced that the waiting period under the Hart-Scott-Rodino Anti-Trust Improvements Act applicable to TransCanada’s proposed acquisition of Columbia Pipeline Group Inc. was terminated early by the U.S. Federal Trade Commission. Pending shareholder approval, the company now anticipates closing the $10.2 billion transaction effective July 1, 2016
All-Cap Growth Basket
CGI Group (GIB.a) – CGI announced a 10-year agreement with Sears Canada to support the retailer’s strategy to re-engineer its technology platforms.
U.S. Growth Basket
Home Depot (HD) – “Home Depot’s earnings were better than expected in more than one way”
ETF Maximum Growth Basket
“Retirement: More Fun Than You’ve Heard” (Forbes)
Week at a Glance
Full report attached
Reads of the Week
- “Strong Run for Canadian Equities” (Bloomberg) BlackRock Chief Investment Strategist for Canada Kurt Reiman gives his insight on why Canadian stocks are outperforming this year to-date
- “Cumberland Advisors Market Commentary – Looking North to Canada” (Cumberland Advisors)
- NBF Economics and Strategy Morning Comment: Brexit and a Fed rate hike? Markets are getting edgy in the run up to the Brexit vote (June 23) and the possibility of a Fed rate hike on June 15 (two Fed governors said Tuesday that the June meeting is “live”). The USD is strengthening and real interest is moving higher. How long will this situation endure? Let’s start with Brexit. Polls are indeed quite close at this point and the outcome can differ depending on the pollster (see attached charts). Morning Comment
- “Income seekers: Four mistakes to avoid” (Morningstar)
- “How To Stack The Odds In Your Favor” (Irrelevant Investor)
- “How China’s affection for Canada’s real estate is reshaping the nation’s housing market well beyond Vancouver” (Maclean’s)
- “Barry Ritholtz: Election “uncertainty” isn’t messing with markets” (Bloomberg) via The outcome of the presidential race is merely unknown. That’s something entirely different.
Monday May 23rd – Victoria Day holiday – Canadian Markets closed
Tuesday May 24th – New Home Sales
Wednesday May 25th – Bank of Canada Rate Decision
Thursday May 26th – Initial Jobless Claims, Pending Home Sales MoM
Friday May 27th – GDP Annualized QoQ
Monday May 23rd – None
Tuesday May 24th –
Wednesday May 25th –
Thursday May 26th – Royal Bank of Canada, Toronto-Dominion Bank/The, Dollar General Corp
Friday May 27th – None
Have a good long weekend!