In This Week’s JMRD Market Observer
- JMRD Diversified Income & Growth Basket & JMRD All-Cap Basket Q3 Updates
- NBFM Forex (October 2016) – Can OPEC rekindle loonie?
- Asset Allocation Strategy: Between a rock and a hard place
- Retirement Corner
- Week at a Glance
- Reads of the Week
- Economic Calendar
- Earnings Reports
JMRD Diversified Income & Growth Basket & JMRD All-Cap Basket Q2 Update
The third quarter was rather calm in the global markets. The VIX Index, which measures the volatility of the US stock market (the higher the VIX, the higher the volatility), started the quarter at 15 and ended the quarter just above 13. The only spike in the VIX occurred in mid-September (from 12 to 20) when market expectations for an interest rate hike in the US were seemingly back on the table after certain FED officials intimated to the press that rates may indeed be moving higher. The September FED meeting came and went without a rate hike and markets settled down again. Another noteworthy event from the quarter was OPEC’s commitment to scaling back production in an effort to expedite the balancing of the oil market. Oil prices traded in a range between $40 to $50 during the quarter, but after the OPEC announcement, realized a bump of almost 10% in the following week. Oil is currently trading at $50 per barrel.
On the docket for the final quarter of 2016 are: Two US Federal Reserve meetings, in November and December, with expectations of an interest rate hike coming in December; the European and Japanese Central bank meetings which will be highly scrutinized as the efficacy of negative interest rate policies come into question; and the main event, the US election, with Hillary Clinton leading in the polls at this point (but not by much). There will be no shortage of market moving events and we will continue to actively managing the baskets and take advantage of opportunities as they arise.
Before we get into Basket specifics, we always like to provide you with a perspective on how the various global indices and commodities performed in the quarter. The Q3 data is provided in the table below.
Today we will discuss the two Canadian mandates which the Team manages; The JMRD Diversified Income and Growth Basket (DIG and the JMRD All Cap Basket (ACB).
JMRD Diversified Income & Growth (DIG) Basket: 2015 Update
The DIG Basket followed up Q2’s 4.37% return with a 4.09% in return in Q3.
The most notable performance in the quarter was Dollarama (DOL). Despite some sluggishness in the discount retailer space in the US, Dollarama reported very strong quarterly results in Canada and the stock was up 13.5% in Q3. Dollarama is our biggest weighting in the DIG Basket at 7.6%. Next in line was Northland Power (NPI), an independent power producer focusing on clean, renewable energy. The company has said that it may need to find a strategic partner to fund certain attractive growth prospects in the future and it immediately became a potential takeover target due to the quality of the company’s long-life assets. There is also renewed interest on the part of pension funds to partner with power producers and this could provide a continued tail wind for NPI and similar entities. NPI was up 10.8% in Q3. Whitecap Energy (WCP), the biggest contributor in Q2, put in another good showing in the third quarter with a 10.9% gain. The OPEC decision to cut production at the end of the quarter helped WCP gain some ground.
It was a pretty quiet quarter for transactions for the DIG Basket. We trimmed a few shares of Dollarama just to lower the exposure to under 10% and we initiated a position in Open Text Corp (OTC), a provider of software products and services that assist organizations in finding, utilizing and sharing business information from any device. This company has become a success story through acquiring smaller software companies around the globe and we think the management team will continue to deliver. In September, Open-Text moved 7% higher after it announced it had agreed to buy Dell-EMC’s enterprise content division for $1.62 billion. We also added to our position in Northland Power after the company announced its intention to seek a strategic partner.
Below is a snapshot of the current holdings. The current annual cash flow is $446 for a yield of 2.81%.
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 $15,900 making the minimum initial position approximately $31,800, which is two Baskets. This amount will continuously change as the prices of the DIG Basket components fluctuate on a daily basis. Subsequent purchases can be made in one Basket increments.
JMRD ALL-CAP BASKET (ACB):
The All Cap Basket (ACB) is meant to be a complementary holding to the DIG Basket above. The ACB invests in a number of smaller, growth-oriented companies that may, or may not, pay a dividend. After posting a return of 1.35% in Q2, the ACB realized an impressive return of 7.77% in the third quarter. Since we launched this basket in October 2013, it has an annual compounded rate return of 14.87% versus the TSX Total Return of 8.0%.
The best performer in Q3 was Savaria Corp (SIS). Demographically, Savaria is in the right sector as it offers a range of stair lifts, platform lifts and residential and commercial elevators. On September 15th, the company announced a 30% dividend increase, which indicates management’s comfort level in the future of its business. SIS was up 36% in Q3. Constellation Software (CSU) has acquired a large stable of specialty software companies over the years, operating in both the public and private sectors. CSU was up 16% in Q3. After lagging in the second quarter because of the Brexit vote due its higher exposure to the UK market, software company CGI Group (GIB.A) posted a 12.7% return for the quarter. Honourable mention goes to CCL Industries (CCL.B), the specialty packaging company, which gained 12% in the third quarter.
During the quarter, we sold our half position in Alimentation Couche Tarde, and trimmed our position in CCL Industries to lower the weighting to under 10%. Once a security gets through a 10% weighting in a basket, from a risk management perspective, we feel the need to lower the exposure. We also continued to trim our position in Exco Technologies (XTC), which continues to lag overall. We will be completely out of this position in the next week or so. We increased our positions in Premium Brands, a producer, marketer and distributor of specialty food products and Innergex Renewable Energy (INE).
Below are the current All Cap Basket holdings.
As mentioned above, The All Cap Basket is more of a growth oriented investment to complement the DIG Basket. The minimum purchase for the All Cap Basket is 4 Baskets or $60.500, with subsequent purchases of 1.5 Baskets, or about $22,700 at current prices. And again, this amount will continuously change as the prices of it constituents change on a daily basis.
NBFM Forex (October 2016) – Can OPEC rekindle loonie?
- The US dollar has room to run, more so considering markets are yet to price a full interest rate hike for this year despite the Fed’s repeated warnings. Markets are also not pricing in the two rate hikes the Fed expects to deliver next year, let alone the six additional hikes slated for the subsequent two years. So, based on yield expectations alone, downside risks seem to be limited for the USD even over the longer term.
- The European Central Bank and Bank of Japan both seem unable to stimulate their respective stagnant economies. Monetary policy seems to have reached its limits. Not only is demand weak despite loose policies, but negative interest rates may be doing more harm than good in an already weakened banking sector, particularly in Europe. Absent further debasement policies, the euro and yen may not depreciate all that much from here. We have raised our targets slightly for both currencies relative to the USD.
- Under pressure over much of September, the Canadian dollar eventually found some support as oil prices rallied late in the month. Markets welcomed OPEC’s decision to reduce supply, unconcerned about whether or not the deal is enforceable. But with large budget deficits to finance, there are significant incentives within the cartel to raise revenues by maximizing output to gain market share. As such, we don’t expect much of a dent in the supply glut, something that could bring oil prices back to earth and hence put the Canadian dollar under pressure. Adding to the loonie’s woes is its dependence on short term foreign capital inflows which could reverse if investor sentiment sours, say from a stock market correction. The Bank of Canada is not helping with its persistently dovish statements. We expect USD/CAD to be in the 1.30-1.40 trading range over much of the next 12 months.
Asset Allocation Strategy: Between a rock and a hard place
- Domestically, it’s undeniable that U.S. treasuries have benefitted from a very favourable environment in recent years. Not only have global risks such as Grexit and Brexit pushed the Fed into constantly postponing any projects to hike, but these have also spurred global demand for safety assets. The fact that some European financial institutions are facing difficulties due to overly accommodating central banks only increases the demand for treasuries, and creates yet another negative feedback loop.
- We suggest an underweight in fixed-income products as well as taking a defensive position duration-wise. We do not expect any major economic downturn in the coming months. So, we think being more aggressive on the credit side will give investors better return prospects, as this strategy has the benefit of offering higher yields while mitigating the impact of a potential hike.
- As of now, concerning the OPEC deal, there are too many unknowns for the news to have an impact on medium- to long-term projections. Consequently, we think the range set since 2016’s Q2 should persist for the rest of the year.
- As investors are not expecting any economic downturn in the U.S., they are betting that stocks will over-perform their fixed-income counterparts, and for good reason — the statistics are on their side. Since 1975, equities have over-performed bonds by an average of roughly 6% on an annual basis when there’s no recession, while underperforming by 11% where there is one. We don’t expect such a gap in the coming years, but we think fixed-income products are facing many more headwinds going forward. Consequently, we suggest keeping some liquidity on hand to invest when headwinds present themselves, such as a risk-off event. (Full note attached)
Reads of the Week
- Economic News – Canada: Employment surges in September OPINION: This morning’s report was significantly above expectations, employment registering its strongest gain in more than four years. A small caveat: most of the jobs were in the self-employed category and tilted towards part-time. Moreover, we note that Quebec’s second best performance on record is mainly attributable to a 4.5 standard deviation surge in the education sector (+23K). Such statistical anomaly usually reverse in the following months. However, it remains that by itself, the 23K rise in full-time jobs at the national level in September following the 52K surge in August is impressive, recouping most the prior months’ losses. On a regional basis, the rise of employment in central Canada for a second consecutive month is welcomed since Canadian labor market health cannot rely exclusively on BC’s performance. Moreover, the Alberta labor market is showing signs of stabilization with a second consecutive month of job creation (middle chart). Nationally, average monthly gains for the first 9 months of the year now stand at 12K, roughly in line with the performance of the past three years. This being said, firms are using workers less intensively as shown by the downward trend in hours worked in 2016. Going forward, we still expect the pace of job gain to moderate as Canadian firms will want to restore profit margins. (Full note attached) Economic News
- “Mr. Market doesn’t care about your politics” (Bloomberg)
- “Ottawa closes housing exemption tax loophole” Liberal’s send a clear message: You need to live in Canada for tax benefits (Money Sense)
- “What Should and Shouldn’t Worry Us About Deutsche Bank” By Mohamed A. El-Erian (Bloomberg)
Monday October 10th – Thanksgiving Day in Canada
Tuesday October 11th – Canada Housing Starts;
Wednesday October 12th – US Federal Minutes from September Meeting
Thursday October 13th – Canada Teranet/National Bank Home Price Index; US Initial Jobless Claims
Friday October 14th – US Retail Sales; US Producer Price Index
Monday October 10th – Canadian Market Closed For Thanksgiving
Tuesday October 11th – Alcoa
Wednesday October 12th – CSX Corp
Thursday October 13th – Wynn Resorts
Friday October 14th – Citigroup, JP Morgan, Wells Fargo
Have a good long weekend – and GO JAYS!