Oct 24, 2016

Peter Brieger's Top Picks: October 24, 2017

BNN Bloomberg

Peter Brieger , BNN

Peter Brieger, chairman and managing director at GlobeInvest Capital Management

Focus: North American large caps
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MARKET OUTLOOK
For the past several years we have made the case that given the severity of the 2008 to 2009 recession, it would take much longer than usual to reach something close to a normal economic recovery. And that in fact is what has happened. As we complete the fourth quarter and move into 2017, there are increasing signs that the U.S. economy is picking up momentum, even though there are still some gaps in contributions from several drivers of GDP growth. In the important consumer sector, average hourly earnings are rising as is overall employment, which has led to an increase in consumer spending. For example, auto sales remain near their recovery peak and housing remains strong in spite of a weather-related dip last month in residential and a likely one-month pause in multi-residential starts. Capex and exports are starting to pick up, however a recent jump in the U.S. dollar may retard the latter’s recovery. Inventory accumulation is still in the doldrums.

In Canada, we remain positive as some stability in oil prices, should it prove to be durable, may be the basis for the start of a more sustained economic pickup led by activity in the WCSB.

All that said there are still some significant global uncertainties. The first is the looming U.S. election, about which I won’t comment until the results are in. In Europe, it will be interesting to see how the U.K. Court rules on whether Prime Minister May can invoke Article 50, which would start the Brexit withdrawal negotiations, and what the outcome of this year’s votes in Italy is as well as next year’s votes in France and Germany.

Turning to bond and equity markets, we remain negative on the former and positive on the latter in both Canada and the U.S. Until we see a pickup in economic activity, rates are likely to stay low. In the U.S. bond market, yields are rising in anticipation of a quarter point rate increase by the Fed in December, although Fed Chair Yellen has indicated she is in no rush to enact one. In my view, the more likely cause of any rate rise, particularly at the mid- to long-term part of the yield curve, is a continuing increase in the U.S. CPI. The latest year-over-year reported figure was 1.5 per cent+, which was an increase from 1.1 per cent in August and 0.8 per cent in July. However, as stated, I think there will be no immediate threat of a flattening of the yield curve, which has been the death knell of economies and equity markets in the past. On the other hand, a steepening of the yield curve would be helpful to North American banks’ earnings.

As for the U.S. equity market, a further rise can come from either an expansion of its price-earnings ratio and/or a pickup in reported earnings. While I think an expansion of the PER is possible, the more likely impetus to stock prices will come from the latter. We should start to see an improving trend with Q3 results. We remain positive on equities.

I don’t think this commentary would be complete without some reference to the forthcoming Brexit negotiations and the negative conclusions many are jumping to. In my view, it is far too early to start factoring in something that may never occur or if it does, may be in a form not easily recognizable today. My reasons are:

The Court decision may take time to reach a decision.
What will happen if the Prime Minister is forced to face Parliament for approval and it says “no”?
If Parliament approves, negotiations are unlikely to start until spring 2017 at the earliest and could take as long as two years to complete. That puts us into 2019.
At that point, the Council of the European Union votes on the proposed agreement as does the European Parliament. Finally, each of the 27 EU members must agree, not to mention areas within states — think Wallonia in Belgium and its opposition to CETA.
That puts any conclusion into possibly 2020 at best. Until then, the EU functions as it does now.
The EU’s current budget expires in 2020.
It is probably not lost on the EU that the U.K. is the second-largest net contributor (10 per cent or 13.95 billion euros) to the total EU budget.
If the U.K. leaves, the EU will have to ask the remaining members to make some tough choices. For example, each member could increase their contributions or the EU budget could be cut, resulting in reduced subsidies in key areas, i.e. agriculture. Finally, the EU could look for new sources of revenue, i.e. higher duties on imports and/or other measures. Good luck, as any of these three alternatives would, in my view, further roil internal EU relations and lead to no decision.

Given the potential severity of the impact on the EU fabric, I think that either the U.K. and/or Europe may become considerably more flexible in their negotiations. The eventual outcome may not be as negative as some predict.

TOP PICKS

ENBRIDGE (ENB.TO) — 10/21 close $58.76; One-year consensus price target: $62.27; Target gain: 6.0 per cent; Yield: 3.6 per cent; One-year target total return: +9.6 per cent; Disclosure: NYYN; Date and price of last purchase: 10/20/16 at $58.22)
With the acquisition of Spectra Energy (estimated closing in Q1 2017), the combined companies will represent a major North American energy powerhouse. Currently, the combined entity will have $26 billion in secured projects out until 2019 and a potential additional $48 billion beyond then. For investors seeking increasing yields “at book,” current target dividend growth would provide a yield of 5.02 per cent in 2019 and if further target dividend increases take place, 6.07 per cent by 2021.

TD BANK (TD.TO) — 10/21 close $60.00; One-year consensus price target: $61.80; Target gain: 3.1 per cent; Yield: 3.7 per cent; One-year target total return: +6.7 per cent; Disclosure: NYYN; Date and price of last purchase: 10/05/16 at $58.22).
Canadian banks currently face three macro headwinds: ongoing pressures from fintech innovators; a slowing in mortgage growth rates because of tougher lending standards for those home buyers who have less than a 20 per cent down payment; and a federal government proposal that mortgage lenders assume five to 10 per cent of the total outstanding value of a defaulted mortgage (before any recovery). I anticipate that banks will successfully deal with all three issues and their growth will continue, albeit at a possibly slower rate. On a micro basis, TD has teamed up with TD Ameritrade to purchase Scottrade Financial Services, reportedly one of the five largest in the U.S. Cost synergies are estimated to be about $450 million. Also, among other things Scottrade has $170 billion in assets under management, including $2.5 billion in mortgages, $700 million in commercial loans, three million clients and 500 branches, which could fit into TD’s U.S. branch network

CENTRAL FUND “A” (CEFa.TO) — 10/21 close $17.64; One-year price target: $19.50; One-year target gain: 10.5 per cent; Yield: 0.01 per cent; One-year target total return: +10.6 per cent; Disclosure: YYYN; Date and price of last purchase: 10/06/16 at $17.53.
I think that gold will benefit from seven positive catalysts during the next several years: improved financial discipline among producers resulting from the pain of lower bullion prices; rising inflation; political and financial uncertainty; a desire for wealth preservation in real terms; a demand supply deficit in bullion because of declining mine supplies; a potential bullion short squeeze; and further central bank buying.