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Group: Canadian Blue-chip Industrial Forum
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Brian Madden's Top Picks: Nutrien, TD Bank and Manulife
A tug-of-war between a slowing economy and expectations of more accommodative interest rate policy continues to play out. Stocks and bonds are substitutes for one another, and the role of dividends (or alternatively earnings or cash flow, as proxies for potential future dividend payments) in setting stock prices is analogous to the coupon payment on bonds. So, when interest rates fall sharply as they have recently, the future stream of dividend payments from a group of stocks becomes more valuable. Skeptics refer to this phenomenon as “TINA” (there’s no alternative), meaning that as rates fall ever closer to zero, return-seeking investors are left with little choice but to dial up the risk profile of their portfolios by swapping bonds for stocks. We see low rates as an enduring secular reality of a highly leveraged, low economic growth world and recognize that at the margin these low rates do push up the fair value of stocks.
We acknowledge an ongoing global growth slowdown and the legitimate spectre of a recession on the horizon as the reason for central banks from Brussels to Washington to Ottawa turning more dovish this year. It may seem counterintuitive to talk about recession when job creation is robust, with unemployment rates in Canada and the U.S. near five decade lows, but the onset of a recession is a subtle event, which occurs as the economy peaks, not as it troughs, so by definition, conditions are necessarily at their most ebullient at the onset of a recession. Our expectation is that the next recession will be more of a garden variety rather than a “great recession” or the financial crisis as we saw in 2008 because the buildup of speculative excess and overinvestment that precipitated such a deep, long recession are largely absent in the economy today.
We remain vigilant to domestic and global macroeconomic and geopolitical developments, but recognize that how events unfold in these realms is entirely outside of our control. What we can and do manage is the structure and composition of our portfolios and, as always, these are built very much with a long-term focus. We select companies with strong and well-entrenched competitive advantages within attractive industries that we expect will grow and create shareholder value over a multi-year period, both through recessions and economic expansions. High profitability, disciplined capital allocation policies (modest capital spending, steady dividend increases and share buybacks) and low dispersion in earnings forecasts are some of the hallmark characteristics of our portfolios in general and even more so in recent quarters. This combination of characteristics typically results in superior sales, earnings, cash flow and dividend growth over the medium to long term. Where these fundamentals go, share prices more often than not will follow.
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Ross Healy's Top Picks: Newmont Goldcorp, Valero Energy and Manulife
The stock market as epitomized by the S&P 500 has remained in a range-bound trade by what we refer to as structural support at two-and-a-half times book value (roughly 1,550 basis points) at the lows and its fair market value (roughly 3,075) at the peak. We find it very intriguing that the range of the values at those two parameters has barely budged over the past 12 months.
Structural support, an adjusted price-to-book measure, is related to balance sheet growth and therefore we can see at a glance that there has been almost no growth in this important area. Not that this should be a surprise, as share buybacks have taken all balance sheet growth away for some time. The surprise is that our fair market value measure, which is directly related to overall earnings growth, has also barely budged more than 25 points either way over the past year. Consider that the earnings forecasts that we use in its construction are based on analyst consensus earnings, even after all of those buybacks have been factored in, earnings forecasts looking forward one year show no visible overall earnings growth not only for the rest of 2019, but also well into 2020.
Since the S&P 500 has yet to exceed its fair market value as long as we‘ve been using our measure, I have to say that the index is far closer to a potential top than a springboard for much higher prices in the coming months ahead, which some seem to be expecting.
Earnings for the first quarter for 2019 were down and in the second quarter they’re also likely to be down, but if you believe the analysts, there appears to be no visible earnings recovery (which the market bulls are counting on for their positive market case) for the next four quarters.
The bottom line is, if you think that earnings weakness in the first half is temporary, and then don’t whine at me if I see no improvement: whine at the 10,000 or so analysts that produced the numbers that I have to work with. Someone is wrong, either the bulls or the analysts.