Brian Madden, Senior Vice President, Goodreid Investment Counsel

FOCUS: Canadian Equities

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MARKET OUTLOOK:

Equity markets have rebounded very nicely off their post-Brexit lows. Canadian stocks have broken a 5+ year spell of lagging our southern neighbours, led by the commodity complex, which had been left for dead until quite recently. With oil back in gear, and gold making what must be considered at least a convincing counter-trend medium-term rally, Canadian stocks are shining once again with the TSX up 12 per cent year-to-date. 

The loonie too has mounted an impressive rally off its winter lows. And Janet Yellen herself has validated the ongoing economic expansion with her remarks at the Fed’s Jackson Hole symposium this week. 

So, what next? The TSX trades at 1.9x book value vs. its 30 year historic average of 2.1x and at 19x forward earnings; exactly in line with its 30 year historic average. But, Canada is nothing if not a cyclical market, and it’s important to note that earnings are 17 per cent below long term trend levels. So, there’s still gas in the tank to fuel stock price appreciation, even absent any further multiple expansion. Moreover, while earnings on a reported basis for the TSX are falling 2.5 per cent per quarter, analysts expect that decline to flatten out next quarter and to rebound significantly in the year ahead. We’ll see, of course. And like all prudent investment managers - we’re from Missouri, the “Show Me” state - we don’t invest in hopes and dreams, but rather in proven businesses that are executing well and meeting or ideally exceeding our expectations. In that regard, banks are expected to continue to offer up a good combination of income (4 per cent yields for the big banks) and growth given their dominant franchises in an oligopolistic industry. 

Consumer names are always ripe for active stock pickers, given the idiosyncratic nature of the sector, mis-pricings continually abound in that space. And exposure to quality cyclicals is going to be important as Canada emerges from what has been at least a regional, if not statistically a national recession. Rate hikes are off the table in Canada this year, given an economy that is operating below potential. Rate cuts are a longshot too though, given a serious reticence on the part of the central bank to pour more fuel on the raging inferno that is the Canadian housing market. Of course, rate hikes are absolutely on the table in the U.S., particularly post-election, but potentially as soon as next month with Fed funds futures implying a 26 per cent probability of a hike at the September meeting. But a rate hike in the U.S. ought not to derail the economy or the markets, given the low level from which we are starting and given likely soft rhetoric from the Fed about the pace of future hikes. Skeptics may note that the current bull market in the United States is long in the tooth, having in the minds of many been kicked off in March of 2009, some 7.5 years ago, although arguably the current U.S. equity bull market began in earnest in October 2011 in the wake of the U.S. fiscal crisis and sovereign debt downgrade, which ushered in a bona fide bear market with the S&P 500 down 21 per cent from peak to trough; a bear market so brief and shallow relative to its predecessor that most investors seem to have no recollection whatsoever of it. 

Here in Canada, we are much, much earlier in the cycle, with the TSX having rallied 26 per cent off the lows which we saw just seven months ago in January after a frustrating 16-month bear market. But in any event, bull markets don’t die of old age; a recession, a sharp tightening of monetary policy or a sudden financial/systemic shock (like in 1987 or 1998) is typically required to derail the uptrend. With respect to the first risk, there is no sign that recession is imminent in the United States or in Canada. With respect to the second risk, the likelihood of a sharp tightening of monetary policy is very low with inflation in check on both sides of the border, with lingering slack in both economies and with global deflationary forces exerting a tremendous gravitational pull lower on rates in all major economies. And as for the third risk, the unknown unknowns are what make our jobs interesting and challenging, and by definition these risks are extraordinarily difficult to foresee. Electoral uncertainty south of the border, unease about perceived speculative excesses in regional housing markets in Canada, and wildcards like OPEC policy and geopolitics generally, will give bears and pundits lots to chew on in the weeks and months ahead. However, in our view conditions remain quite favourable to equity investors, but are admittedly more challenging for income seekers and bond market investors in the current low-rate regime.

Top Picks:

Alimentation Couche-Tarde (ATDb.TO)

Latest purchase August 16 @ $62: Alimentation Couche-Tarde is the largest convenience store operator in North America. The company has a 20+ year record of growing earnings and enjoys high and rising profitability as measured by return on shareholder’s equity. Their increasing size and scale is driving procurement advantages relative to rivals, so they can price sharply on fuel to draw traffic. Shoppers are then enticed into attractive, modern and well merchandised stores to buy chocolate bars, coffee, cigarettes, prepared foods, etc., which carry 34 per cent gross margins vs. the 5-to-6 per cent margins on gasoline.  Management are extremely capable acquirers and integrators of businesses, which is extremely important in this still fragmented industry where there are more motivated sellers than qualified buyers.

Magna International (MG.TO)

Latest purchase August 17 @$52: Magna, Canada’s largest auto parts company offers exposure to the auto cycle which is still going strong and may extend further from the current run rate of around 18m cars/year in the U.S. The business is geographically well balanced between North America, Europe, and Asia and Magna is outgrowing the industry in each region as their innovations in “light-weighting” for fuel efficiency, electronic transmissions, and advanced safety/driver assistance breakthroughs have resonated well in the marketplace. A recent change in financial governance is driving higher return of capital to shareholders via buybacks and the shares are inexpensive at 7x earnings vs. peers at 11x and relative to its own historic average which is closer to 9.5x.

CCL Industries (CCLb.TO)

Latest purchase June 24 @ $230:  CCL Industries is classified as a materials stock, but is really nothing like gold or base metals mining companies that populate their sector - it really ought to be thought of as an industrial company focused on packaging, containers and labels and serving clientele across a number of sectors, most notably large multinationals in the consumer packaged goods space. CCL is experiencing mid to high single digit organic growth, and bolsters this growth as a capable and proven serial acquirer of complementary businesses. They recently bought Checkpoint for roughly $500 million, and expect $40 million of synergies from the acquisition. EPS have grown at a torrid 40 per cent pace per annum between 2012-to-2016.  

Website: www.goodreid.com