Jun 27, 2016

Peter Brieger's Top Picks: June 27, 2016

Michael Chu , BNN Bloomberg

Peter Brieger , BNN

Peter Brieger, Chairman & Managing Director, GlobeInvest Capital Management

Focus: North American Large Caps

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MARKET OUTLOOK:

Earth-shattering as the Brexit vote may seem to be, in my view it must be placed in perspective relative to other longer-term significant influences and trends that also portend major changes in world affairs. These would include the impact on European unity from the forthcoming NATO meetings; the impact on all phases of our life by the accelerating changes in new technologies such as robotics, artificial intelligence and 3D manufacturing to name a few and whose impact has partially been the cause of the unrest to date; a reversal of globalization as these new technologies make it more economic to manufacture at home; the impact of these trends and demographics on long-term employment and productivity. As ever, in politics as in other things, expect the unexpected. The world-wide anger we see has led to a cry for change: But a change to what?

However, at this point, the immediate focus is on the impact of the Brexit vote. Given the magnitude of the uncertainties the outcome has created and given the large number of permutations and combinations about what might happen, it is far too early to reach any firm or lasting conclusions.

Given those permutations and combinations, in trying to determine future market action, let’s deal with what we know.

The referendum’s outcome is not binding. The UK Parliament has the final vote. While some say it would be political suicide to ignore the massive English county vote in favor of “leave,” the post vote reaction and the composition of the total vote might influence Members of Parliament who generally were more in favor of “stay” versus “leave.” (See comments below);
When the next Prime Minister triggers Article 50, the formal request to withdraw from the EU, it is the start of what could be a two year period of intense negotiations about the actual details of the withdrawal. It could go on longer;
Upon a final agreement, the first step is that each of the remaining 27 EU Members must ratify it. Then it has to go back to the British Parliament for final ratification. Some suggest that this could add an additional year to the process;
Until that time the UK remains a Member of the EU and all current rules, regulations and obligations remain in place;
And as of this morning a new question: According to recent comments by Nicola Sturgeon (the Scottish First Minister) “Can the Scottish Parliament really block the UK’s departure from the EU?” As stated, expect the unexpected!

Two and three years is an eternity in the political world and at this stage, no one knows what might happen. One interesting speculation is that if the negotiations result in the UK getting much of what it wants, then a subsequent referendum might reverse last Thursday’s vote. How likely is that? At this point we don’t know.

Already we are seeing a softening of last Friday’s comments from the Foreign Ministers of the original six EU Members calling for a speedy withdrawal by the UK and the imposition of harsh conditions on the UK to discourage other EU Members from leaving. No doubt yesterday’s Spanish vote that once again led to a “hung” government may have partially led to a less strident tone. Furthermore, a powerful voice of moderation has now been heard. Angela Merkel, Germanys’ Chancellor is most conscious that in 2015 Germany was the UK’s main trading partner in goods even surpassing the U.S. First crack in the EU front? Also, if the remaining EU Members are seen to come down too hard on the UK, it may further build the momentum for other separatist referenda in other EU countries.

Of the total 33,551,983 votes cast the Brexit’s margin was 1,269,501 or 3.78 per cent of the total. If from the UK’s point of view, a better deal could be negotiated, then another referendum’s outcome might be quite different. Further, the “stay” side’s votes were almost entirely from Scotland, Northern Ireland and London. The majority of the “leave” vote came from the English counties. Finally, while I don’t have the numbers, I note that 18 – 49 age group voted to stay while the 50 plus voted to go. These are things I think the UK government of the day would want to keep a sharp eye on.

In reviewing a myriad of opinions about what might happen to markets, I was struck by the always sensible comments from David Rosenberg. He makes the point that ”this panic reaction will prove overdone and while cash will still be your friend in the coming days and weeks, it will not likely be much beyond that.” One certainty is that markets hate uncertainty which will most likely lead to a greater volatility than normal and over-reactions. That will mean that there will be cheap assets on offer.

I think investors should show short-term prudence about immediately rushing in to markets. However, given the likely continuation of low interest rates and bond yields in North America compared to the yields on equities, that may cause investors to further focus on equities. Which parts of the equity markets? In my view, mainly on those companies with good North American exposure and good earnings and dividend prospects.

Top Picks:

Agrium (AGU.TO)

Close 06/24: $119.58: One year target price: $121.70; Target Gain: 1.8 per cent; Yield: 3.8 per cent; Target one year total return: +5.6 per cent: Date and price of last purchase: 03/07 @ $116.21. The long-term thesis for AGU is still in place – that is an increasing world population must be fed. In the shorter-term the potential increase in major “ag” company M & A opens up substantial potential for its private brand retail business. Its balance sheet is in excellent shape and looking out to 2020, the company’s target dividend rate is $5.00 a share on a free cash flow per share target of $10.00.

Home Depot (HD.N)

Close 06/24: $126.40; One year target price: $147.90; Target Gain: 17.0 per cent; Yield: 2.2 per cent; Target one year total return: +19.2 per cent; Date and price of last purchase: 06/24 @ $123.23. Housing is one of our favorite North American investment areas and HD is the leader in home improvement product sales and service. Given the sharp improvement in existing home sales (90 per cent of all activity), rising consumer employment and incomes and the increase in equity of most existing owners’ homes, it augers well for purveyors of those products and services.

Royal Bank (RY.TO)

06/24 close: $77.21; One year target price: $59.85; Target gain: 6.7 per cent; Yield: 4.2 per cent; Target one year total return: +10.9 per cent: Date and price of last purchase: 06/24 @ $77.77. Canadian banks’ exposure to the UK and Europe is minimal. Given our continuing positive outlook for the US economy, Brexit notwithstanding, we think that Royal’s, TD’s and BMO’s US exposure augers well particularly for Royal. That is because it’s recent purchase of City National (a US bank) opens up significant potential for the expansion of its wealth management business and cross selling of Royal’s products and services.