**May 27th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer Market
- BoC Policy Monitor – No surprises, the Bank of Canada’s policy stance left unchanged
- Canadian Life Insurance Q1 f2016 Review: More Cowbell
- Daniel Straus – NBF’s ETF Expert on BNN
- JMRD Basket Corner
- Week at a Glance
- Reads of the Week
- Economic Calendar
- Earnings Reports
BoC Policy Monitor – No surprises, the Bank of Canada’s policy stance left unchanged
As widely expected, the Bank of Canada left the overnight rate unchanged at 0.50% today. The central bank says that Canadian growth in the first quarter seems to be in line with what it had projected back in April’s Monetary Policy Report (+2.8% annualized). However, Q2 growth (initially estimated by the BoC at 1% annualized) is likely to be revised down due to the devastation caused by Alberta wildfires „Ÿ the central bank estimates disruptions to oil production will cut about 1 1/4 percentage points off real GDP growth. However, a rebound is expected in the third quarter with reconstruction efforts and as oil production recovers. The central bank noted the regional divergence in the housing market and said that household vulnerabilities have moved higher. The risks to the Bank’s inflation projection remain roughly balanced Bottom line: The Bank’s statement provided no surprises. A downgrade to Q2 growth was expected because of the Alberta wildfires, but so was a subsequent rebound. Assuming curtailments to oil production do not last more than a month; the GDP hit to 2016 growth shouldn’t be more than a tenth of a percentage point according to both our own and the Conference Board’s estimates, i.e. a hit that is not significant enough to prompt a dovish turn by the central bank. What’s next for the BoC? With so much riding on exports, the central bank is unlikely to cause the Canadian dollar to appreciate much from here with hawkish language. True, the annual inflation rate is creeping up (1.7% in April), but it remains below the central bank’s target. The importance of a cheap currency can be seen in the labour market’s performance this year „Ÿ of the 85K jobs created in services this year, more than 30% come from accommodation and food services, a sector sensitive to tourism activity. All in all, with fiscal stimulus in the pipeline, there is no reason for the BoC to change its policy stance. We’re still confident the Bank of Canada will stay on the sidelines until late next year.
Canadian Life Insurance Q1 f2016 Review: More Cowbell
After Q1 f2016, we find ourselves more convinced of the importance of wealth management platforms to offset a stagnant interest rate environment. The utilization of unconventional policy tools by many central banks has made more likely a Japan-like, prolonged period of low long-term interest rates. Moreover, we believe life insurance valuations already express this reality.
That said, the best antidote to a flat yield curve is a gearing to wealth management – the same expansive monetary policy measures discussed above also serve to support asset values (such as equities). In this regard, the most recent quarter highlighted that not every life insurer is equally placed to counteract the pressure on their protection businesses via wealth management growth. In Q1 f2016, despite some operating challenges following substantial equity market volatility at the start of the quarter, we observe a notable gulf between the trajectory of MFC and SLF’s wealth platforms and those at GWO and IAG. Our rank order of preference is as follows:
MFC [OP; $21 PT] We rate MFC Outperform because the company continues to trade below its IFRS book value per share. Given the inherent conservatism within the Canadian actuarial regime – which forces mark-to-market amendments to life insurers’ actuarial liabilities each quarter – we consider the IFRS BVPS to be a reliable estimate of net assets available to common shareholders. Thus, any opportunity to invest in MFC at a price lower than the net asset value of the company strikes us as a good one. Additionally, MFC derives nearly three-quarters of its pre-tax core earnings outside of Canada. Should macroeconomic headwinds dampen earnings growth prospects in Canada, we expect MFC’s valuation will reflect this favourable geographic positioning to a greater degree than peers.
SLF [OP; $47 PT from $44] In Q1 f2016, the company did fairly well in combatting various structural headwinds. Despite the divergence in asset and profitability growth at SLF Canada – reflecting, in our view, the impact of persistently low interest rates, the segment handily outperformed our forecast this quarter. While SLF Asset Management fell well short of our expectations this quarter, MFS demonstrated welcome momentum in net fund flows despite the negative earnings impact of materially heightened intra-quarter market volatility. Moreover, despite weaker earnings than we anticipated this quarter within SLF’s alternative asset and liability-driven investing platform (SLF Investment Management, SLIM) we remain optimistic with regards to the business’ strategic rationale and upside.
GWO [SP; $36 PT] GWO’s results were particularly poor in the U.S. and to a lesser extent, Canada. Specifically, after a lengthy process of slow but steady improvement at Putnam Investments LLC, this quarter’s excessive loss and sizable net fund outflows will undermine the market’s confidence in the platform and could reintroduce a meaningful drag on GWO’s valuation. The weakness in experience gains over the past two quarters may also raise questions about the company’s previously unassailable balance sheet. Should these trends continue, we would expect a materially negative impact on the company’s valuation. However, one quarter does not unwind a lengthy history of stability & we will likely give management the benefit of the doubt for at least another quarter before jumping to this conclusion.
IAG [SP; $42 PT from $40] Within our coverage universe, IAG remains the only company amongst its peers to maintain substantive earnings sensitivity to the Initial Reinvestment Rate assumption (IRR). Importantly, IAG continues to grapple with material operational headwinds (low interest rates, reserving for policyholder lapse, sensitivity to equity market volatility and persistent net fund outflows in its mutual fund business). Until IAG resolves at least one of these headwinds, we expect the company’s valuation to remain close to book value. Nonetheless, with the Federal Reserve nearing another increase to its discount rate, we boost IAG’s price target by $2.
(Full report attached)
Daniel Straus – NBF’s ETF Expert on BNN
This week, Daniel Straus, NBF’s Head of ETF Research & Strategy was interviewed on BNN this week, sharing his thoughts on his top ETF picks. We use Daniel’s counsel quite often and we thought we’d share his interview with you. Some key points are below.
With the ever-growing number and variety of ETFs in the Canadian marketplace, not to mention the U.S., investors have unprecedented power and freedom to create low cost, efficient, and diverse portfolios with exposure to nearly every asset class under the sun.
As of May 2016, there were 450 ETFs in Canada and over 1,900 ETFs in the U.S. With this expanded product selection comes a greater number of decisions and potential pitfalls as investors navigate the array of choices.
We first begin with National Bank’s asset allocation views from our Economics and Investment Strategy Team. These are broad and diversified asset allocation schemes with six basic asset class lines: Canadian, U.S., and International Equities, Bonds, Alternatives, and Cash. We take two specific directions for exposure in each asset class:
- Passive Core for broadest and least expensive exposure – we seek out the ETF with the best quantitative metrics in terms of fees, transaction costs, diversification, and liquidity.
- Strategic Satellite for factor-based or actively managed exposure – where appropriate, we supplement each passive “core” with a strategic ETF that can be alternatively weighted, factor index-based, or actively managed.
Currently our economics team is overweight equities relative to fixed income, and within that category there’s been a gradual switching from U.S. and International stock markets back into Canada during our quarterly rebalance dates. Moving by asset class:
Canadian Equity: Despite the fact that a new reality of commodity prices is setting in, the Canadian economy is showing signs of resilience. First, oil prices have moved up. Second, labour market conditions and other domestic economic indicators look positive. We had strong gains in full-time and private-sector jobs, and higher than expected CPI data for two months in a row (March and April).
U.S. Equity: Albeit haltingly, the U.S. economy continues to expand as well. The probability of a June hike remains low as weak profits have been harming business investments, which has been falling lately. Discouraging payroll and wage growth notwithstanding, the unemployment rate is hovering near multi-year lows at 5 percent and consumer confidence remains high. On the currency front, our model ETF portfolios went from unhedged to currently employing a partial hedging strategy, although there are arguments to be made on both sides in this debate.
International equity: Here we find a higher concentration of risk. The year kicked off with global concerns over a recession in China and falling crude prices, but since mid-February most foreign benchmark indices have recouped their losses. However, risks are still prevalent as global GDP is expected to be relatively slow at 3 percent despite widespread monetary easing policies from central banks the world over. Many factors can reverse the current gains: Brexit, commodity prices (USD strength), rate hikes, sluggish growth, corporate earnings, China, et cetera. Looking internationally, opportunities are there to be found, but we want to be selective in our asset allocation and ETF choices.
Fixed Income: Our asset allocation team suggests that there’s a fundamental tension in the bond markets, in that the Fed wants to tighten (perhaps slowly, perhaps in the long run), but yields have priced in some dovish policy. Although the current outlook for bonds can be challenging, especially in the investment grade universe, it’s important to remember the role that bonds play in an overall portfolio context. Rather than chasing yields and absolute returns, long-term investors should select bond ETFs that fulfill the wider investment goal of diversification and risk mitigation. Hopefully, when yields finally start to rise, the bond portfolio can gradually pick up yield as the investor rebalances among asset classes. Given the liquidity and transparency of many bond ETFs, they offer a tremendous value proposition, especially when compared with traditional cash bonds. Our model portfolios use aggregated bond exposure as the core anchor, supplemented by some investment grade, short term, and global bond ETFs to bring down duration risk and add diversification.
Ishares S&P TSX Capped Composite Index Fund (XIC.TO)
Horizons Active Global Dividend ETF (HAZ.TO)
Vanguard Canadian Aggregate Bond Index ETF (VAB.TO)
JMRD Basket Corner
Keyera (KEY) – Closed their $345M equity financing this week and also announced an area dedication and take-or-pay agreement with a multi-national producer related to construction of a $600M, 300 mmcf/d sour gas gathering and processing complex in the Wapiti area south of Grand Prairie, AB. (Full note attached)
All-Cap Growth Basket
Enercare (ECI) – “Upcoming Investor Day Should Yield Additional Insights” (Research note attached)
U.S. Growth Basket
Dollar General (DG) – Dollar General on Thursday posted earnings for the most recent quarter well above market views as sales at the discount retailer continued to climb and margins improved. During the quarter, same-store sales rose 2.2%, helped by increases in both customer traffic and average transaction amount. The sales improvement marks a departure from other, higher-priced retailers reporting a disappointing start to the year. Chains from J.C. Penney Co. to Target Corp. posted sluggish sales as consumers cut back spending. Years after the global financial crisis, Dollar General still finds itself picking up more customers drawn to lower prices for smaller-size items that are sold closer to their homes. Shares in the company moved higher by over 4% the last 2 days and a new year-high.
Week at a Glance
Full report attached.
Reads of the Week
- “How to Make Better Investment Decisions” (Motley Fool) Optimistic about yourself, pessimistic about everyone else
- “The Most Important Investors Of All Time” (The Irrelevant Investor)
- “Was That a Bear market and is it over?” (The Irrelevant Investor)
- “Home sales go through the roof” (London Free Press)
- “Losers Average Losers” (The Irrelevant Investor)
- “Hold your nose and buy Europe” (Wall Street Journal)
- “Secrets of the Dow Jones Industrials” (Marketwatch)
- “Your Summer Reading List” (Bloomberg)
Monday May 30th – Canadian Current Account Balance, Canadian Industrial Product Price, Canadian Raw Materials Price Index
Tuesday May 31st – Canadian GDP, U.S. Personal Income, U.S. Personal Spending
Wednesday June 1st – U.S. ISM Manufacturing, U.S Federal Reserve Releases Beige Book
Thursday June 2nd –U.S. Initial Jobless Claims, U.S. ADP Employment Change
Friday June 3rd – Canadian Labor Productivity, U.S. Trade Balance, U.S. Change in Nonfarm Payrolls, U.S. Unemployment Rate, U.S. Factory Orders
Monday May 30th – None
Tuesday May 31st – Bank of Nova Scotia
Wednesday June 1st – National Bank of Canada
Thursday June 2nd – Broadcom
Friday June 3rd – None
Have a good weekend!