Brian Madden, senior vice president and portfolio manager at Goodreid Investment Counsel

Focus: Canadian equities
_______________________________________________________________

MARKET OUTLOOK

Equity markets entered 2018 amidst a strong economic backdrop and with an even stronger sentiment tailwind behind them, as euphoria about growth and corporate tax cuts infiltrated all corners of the markets. However, this Goldilocks backdrop soon faltered in late January, with major markets like the S&P TSX Composite shedding 10 per cent of their value during a tumultuous three-week period in late January and early February, before recovering approximately half of those losses. Many investors seemingly were shocked by the swift setback, having being lulled into a sense of complacency by the relative dearth of even garden variety bull market corrections during these last two years. We were not especially shocked or alarmed, though, knowing full well that the unusual, eerie calm that had prevailed since the U.S. elections was the anomaly, rather than the norm, and expecting that as we move into the late stages of the economic cycle, with valuations fair to full, and with interest rate hikes taking hold, this unusual suppression of volatility would start to show some cracks, and indeed this did occur recently.

Bull market corrections unfold in three dimensions: price, time and investor psychology. Prices need to revert back to levels consistent with underlying economic fundamentals, at the individual company level, and in the aggregate, at the major index levels. Time, in this case, is on investors’ side, since the underlying value drivers like sales, cash flow, earnings and dividends for each individual company continue to grow along with the economy overall. As such, slower corrections, like the one we saw in Canada from February to September of last year (-6 per cent over 6.5 months) oftentimes need not be as deep in terms of price declines in order for that all-important price-to-value trade off to reset to attractive levels. Conversely, swifter declines like the one we saw more recently (-10 per cent over three weeks) oftentimes are deeper in terms of price impact — the effect of these is like ripping off a Band-Aid: it stings, but it’s over quickly. Crucially though, in either case, investor psychology needs to reset, such that the pervasive, bulletproof and Teflon-coated dip-buying mentality is somewhat cleansed and purged from the markets — some blood must be spilled and some greed must be displaced by fear in order to shake stocks out of weak hands and to reset markets onto a firmer footing going forward. In our judgment, it is unlikely that at this point, a sufficient reset of investor psychology has occurred to sound the all-clear on this latest bout of market volatility. 

For our part, we strive always to be that strong-handed, long-view investor, poised to buy when great stocks are shaken out of weak hands, and poised to sell and to de-risk portfolios when greed, emotion and heightened expectations are running hot, taking even great companies to prices too lofty for the underlying business to justify. To that end, in late 2017 we had begun to pare back and/or sell outright some of the higher beta (higher risk) and more cyclical names in our portfolio, and in their place initiate new investments in more consistent and higher visibility growth opportunities where the industry structure is attractive and where the competitive advantage and profitability enjoyed by the business is very well insulated both from competition and from economic ups and downs. This process is ongoing. Moreover, we continue to diligently manage asset mix as per each individual client’s investment policy statement, with the goal of navigating even somewhat choppier waters in a way that achieves each client’s objectives at a level of risk that is tolerable and comfortable for them. Practically speaking, in recent months, this has meant taking profits in stocks and adding to cash and bond portfolios, a prospect that gets more and more attractive with each uptick in interest rates as yields on high-quality investment-grade bonds rise to levels not seen for several years, and which serves to illustrate the diversification and risk mitigation benefits of a thoughtfully-designed and diligently re-balanced stock-and-bond portfolio, such as those we manage.

TOP PICKS

NORTH WEST COMPANY (NWC.TO) – Last purchased Feb. 2018 at $27.31
North West Company retails necessities like food, apparel and general merchandise across a network of 225 stores under various banners including Northern, Cost-U-Less, AC Value and Giant Tiger in remote communities in the Canadian north, Alaska, the South Pacific and the Caribbean. Due to long supply chains and complex logistics, most of the markets the company serves are immune from the competitive threat of e-commerce, and moreover, many of their stores are in communities so small as to be natural local monopolies. Accordingly, the company earns net margins and returns on shareholders’ equity well above other grocers and general merchants. With the shares trading at 14.5x expected earnings, which are temporarily depressed as they rebuild and reopen several stores recently damaged by hurricanes, the valuation of the company is very compelling in light of its durable competitive advantage and high-visibility growth prospects that are largely independent of outside economic forces and cycles. 

INTER PIPELINE (IPL.TO) – Last purchased Feb. 2018 at $22.58
Inter Pipelines operates a network of pipelines with capacity to move 2.3 million barrels/day of diluted bitumen and condensate to and from Alberta’s major oil sands projects as well as a smaller network of conventional oil pipelines in Alberta and Saskatchewan, various natural gas liquids processing plants in Alberta and numerous oil storage terminals in northern Europe. The company in December sanctioned a $3.5-billion propane dehydrogenation and polypropylene plant, which is under construction and scheduled to enter into service in 2021, and would be among the first of its kind in Alberta, at a very opportune time when the province is awash with cheap liquids rich natural gas. IPL yields 7.4 per cent and has grown its dividend steadily at a compound rate of seven per cent over the last decade, and should be able to continue to do so, as its business is 80 per cent underpinned by cost-of-service and fee-based long-term contracts, ensuring very stable cash flows with limited commodity or volume risk.

TD BANK (TD.TO) – Last purchased Feb. 2018 at $71.32
TD is Canada’s second-largest bank and second-largest company in any industry, and is also increasingly a force to be reckoned with in U.S. banking and brokerage services. TD earns a 15-per-cent return on shareholder equity and has grown earnings per share at a 6.5-per-cent rate over the last decade, with more than commensurate increases in its dividend as the firm has remained very well capitalized through the cycle. With nearly 40 per cent of its revenues originating in the United States, TD should benefit from recent and expected upcoming interest rate hikes in that country, as well as from the recently enacted corporate tax cuts. Trading at 11.5x expected earnings, and with the stock having found support near its rising 200-day moving average early this month, TD looks well poised to continue its consistent pattern of outperforming the TSX — a feat that it, along with other members of the Canadian banking oligopoly, has accomplished in 20 of the last 25 years.
 

PAST PICKS: APRIL 5, 2017

CCL INDUSTRIES (CCLb.TO) *5-for-1 stock split June 2017*

• Then: $286.70
• Now: $63.38
• Return: 10.53%
• Total return: 11.15%

CAMECO (CCO.TO)

• Then: $14.60
• Now: $11.47
• Return: -21.43%
• Total return: -19.49%

NEW FLYER INDUSTRIES (NFI.TO)

• Then: $49.27
• Now: $57.33
• Return: 16.35%
• Total return: 18.49%

TOTAL RETURN AVERAGE: 3.38%