Ryan Bushell, Vice-President & Portfolio Manager, Leon Frazer and Associates

FOCUS: Canadian Large-Cap Dividend Stocks

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MARKET OUTLOOK:

Oil prices and the Canadian equity market continued their respective ascents in Q2, up 26.1 per cent and 5.1 per cent respectively. For oil, this was the strongest quarter since 2009, as fundamental supply/demand dynamics continued to improve. The S&P 500 gained ground as well, up 2.5 per cent in local currency, however the Canadian dollar appreciated up 0.6 per cent against the U.S. dollar, taking away from returns on foreign equities for Canadian investors.

Q2 was eventful from both a macroeconomic and geopolitical perspective. The quarter began with a stunning special meeting of major oil producers in Doha, Qatar. Saudi Arabia unexpectedly changed course at the 11th hour, thwarting a major production freeze agreement with Russia and OPEC producers (excluding Iran) that had been aiding the oil price recovery through the end of March.

In May, the U.S. Federal Reserve abruptly adjusted guidance toward raising interest rates, sending interest rate traders into a frenzy of adjusting positions. The so-called “Fed Futures” went from a near zero probability of an interest rate increase before September to a greater than 50 per cent chance in just days. Later in the month, a weak U.S. jobs report sent interest rate expectations tumbling back down, however uncertainty remained.

In Canada, tragic wildfires severely curtailed Canadian oil production and economic growth in May. June brought another OPEC meeting that was much more constructive than the “Doha debacle,” a decision not to raise interest rates by the U.S. Federal Reserve and finally, the highly anticipated U.K. referendum on the status of their membership within the European Union.

The surprising decision by U.K. voters to leave the European Union sent brief shockwaves through global financial markets, most acutely felt in the currency market. Global equity markets proved resilient and climbed at the end of the quarter, all but erasing the two days of losses following the “Brexit” decision. We won’t know the ultimate effects of this decision for some time; however we doubt they will have any impact on our investment strategy. Our short-term reaction to Brexit was to take advantage of an opportunity to put a small amount of cash to work in accounts where warranted.

In almost every case, the short-term reaction to the events above was almost immediately reversed. The failed Doha meeting did not cause oil prices to retrace back to their lows, the Fed didn’t raise interest rates in June, and “Fed Futures” briefly priced in the probability of a cut in interest rates, not an increase. Finally, the dreaded Brexit decision did not send equity markets into a downward spiral, as the TSX, S&P 500 and even the London-based FTSE all closed higher on the month.

The modern news cycle can have adverse effects for the long-term investor, while fueling the short-term trading industry’s thirst for tradable catalysts. Daily prices for marketable securities are determined by the diverse motivations of participants. Time horizons can extend from fractions of a second (high frequency traders) to several decades; however intra-day transactional activity is overwhelmingly weighted to those with time horizons that do not extend past the next change in season. Fundamentals such as the ultimate outcome of Brexit will no doubt have an effect on the global economy. Short-term market participants will continue positioning and repositioning for the possible outcomes as more information becomes available. Eventually the market will price securities correctly for whatever the actual impact of Brexit ends up being. In the meantime, a multitude of other events will present their own reactions and outcomes that will affect securities prices on an ongoing basis, making it impossible to accurately quantify the true effect.

Top Picks:

Freehold Royalties (FRU.TO): *also a past pick*

Though Freehold Royalties is up significantly over the past year, we remain convinced that the shares represent compelling opportunity to conservatively participate in the oil and gas sector over the next 12 months and beyond.  The company recently acquired a significant royalty package from Husky Energy that enhances their growth runway.  The shares carry a 4.1 per cent current yield with upside to that payout if commodity prices continue to improve which we anticipate over the next 12-24 months.  Even if commodity prices weaken Freehold’s low capital spending requirements protect shareholder value as we saw when prices were at their weakest earlier this year.  The company trades at a material discount to their major peer, Prairie Sky, and while some discount is warranted, the magnitude of current valuation gap would suggest upside for Freehold shares.

AltaGas (ALA.TO)

AltaGas remains one of our favourite holdings in the energy infrastructure space; however it has not recovered alongside its peers YTD. AltaGas got dragged down just as hard, if not harder than peers in 2015 despite having over 60 per cent of their revenues coming from contracted power generation and distribution utilities but it has not bounced back nearly as much. The company just completed a gas processing plant in B.C. ahead of schedule and under budget, reported better than expected cash flow and increased their dividend by 6.10 per cent, however even after a nice bounce the shares still yield over 6.25 per cent. 

Manulife (MFC.TO)

Manulife has struggled year to date with global macro concerns as well as further declines in benchmark interest rates following the British referendum regarding their membership to the European Union. We feel Manulife represents an opportunity to participate in the demographic trend where baby boomers switch from saving for to spending in retirement. Insurance companies’ wealth management businesses represent a larger share of their bottom line than banks with a stronger positive correlation to interest rates, should rates ever rise. In the meantime, Manulife trades at less than book value and a 4.10 per cent dividend yield allowing investors to be patient. Manulife has also increased their dividend aggressively over the past few years; their dividend is up 42 per cent since mid-2014.

Past Picks:  August 17, 2015

AutoCanada (ACQ.TO)

• Then: $27.41
• Now: $22.90
• Return: -16.45%
• TR: -13.18%

TD Bank (TD.TO)

• Then: $51.76
• Now: $57.14
• Return: +10.39%
• TR: +14.84%

Freehold Royalties (FRU.TO)

• Then: $10.76
• Now: $11.43
• Return: +6.23%
• TR: +13.02%

Total Return Average: +4.89%

Website: www.leonfrazer.com