President-elect Donald Trump plans to make U.S. infrastructure “second to none”. He also plans to cut income taxes. This is likely to lead to higher inflation rates and higher interest rates. That changes the relative attractiveness of various investments. Here are 14 Canadian stocks that could prosper from infrastructure spending—2 engineering stocks, 2 insurance company stocks, the big 5 Canadian banks and 5 utilities and pipelines stocks.
President-elect Donald Trump’s policies are having an impact on stock prices, inflation, interest rates and bond prices. Here’s what we see ahead.
Mr. Trump said the U.S. federal government will invest $1 trillion in infrastructure over the next five years. This includes bridges, roads, trains, airports, seaports and so on. Prime Minister Justin Trudeau also pledged to invest many billions in infrastructure. They both hope that investors such as pension funds will invest a whole lot more. We see infrastructure investment as a fine way to stimulate the economy.
Infrastructure spending is flexible
One big plus is that it offers flexibility. Governments can increase or decrease such investment as needed.
When the economy hits a slow patch, more investment in infrastructure puts unused resources—such as workers and capital—back to work. When growth is humming and the government seeks to reduce its deficit, it could simply let existing projects run their course.
From a long-term perspective, investment in infrastructure makes the economy more productive. People and resources can go to where they’re needed more quickly.
British economist John Maynard Keynes wrote that even very low interest rates will fail to spur investment if confidence is also low. This is the ‘liquidity trap’. Very loose monetary policy has not revived the world economy. Keynes’ advocated using counter-cyclical fiscal policies. That is, accept a deficit and invest in projects until the economy hits its stride.
Stantec and SNC-Lavalin should profit
Infrastructure investment can help some of the engineering stocks that we regularly review. One that comes to mind is Edmonton-based Key stock Stantec Inc. (TSX—STN; NYSE—STN). Even if Mr. Trump is protectionist, Stantec operates across the U.S. as well as Canada. And it now trades on the New York Stock Exchange. The company is unlikely to suffer from ‘Buy America’ programs. Buy.
The fact is, as the U.S. population grows, there’s a need for more infrastructure. In addition, a lot of older infrastructure needs renewal. The U.S. inter-state highway system, for instance, was begun in the 1950s during the administration of Dwight Eisenhower. Many highways likely need renovation.
Canadian infrastructure investment can also assist Montreal-based Key stock SNC-Lavalin Group (TSX—SNC). Buy.
Mr Trump, like most Republican presidents, plans to cut income taxes. Both this and infrastructure spending will put a lot of money into circulation. This is expected to raise the inflation rate.
Inflation will raise interest rates. That’s because investors will need higher interest payments to offset lost purchasing power. Also, the U.S. central bank may raise interest rates to limit the inflation rate to two per cent. We formerly thought that higher interest rates were a long way off. Trump’s triumph likely means they’re closer than we expected.
Higher inflation and interest rates have significant implications for your portfolio. Fixed-income investments, for instance, will likely fall in price as interest rates increase.
Higher interest rates will help financial stocks
Higher interest rates would assist insurance companies. First, they would lower the size of future liabilities. These are discounted at the prevailing rates of bonds with the same maturities. The higher these discount rates, the lower the future liabilities. Second, higher interest rates make it safer and more profitable for insurance companies to invest the insurance premiums into fixed-income investments. This should also improve the solvency of the few gold-plated defined benefit plans that still exist.
Accordingly, we maintain buy recommendations on Toronto-based Key stocks Sun Life Financial (TSX—SLF) and Manulife Financial (TSX—MFC).
Higher interest rates should also raise the profitability of the banks’ traditional lending business. The banks earn a ‘spread’ between the interest they earn on assets, such as mortgages, and the interest they pay on liabilities, such as bank accounts or GICs (Guaranteed Investment Certificates). Higher interest rates and a steeper yield curve can widen these spreads and make their financial intermediary businesses more lucrative.
We maintain buy recommendations on the Toronto-based big five Canadian bank stocks Bank of Montreal (TSX—BMO), Bank of Nova Scotia (TSX—BNS), Canadian Imperial Bank of Commerce (TSX—CM), Royal Bank of Canada (TSX—RY) and Toronto-Dominion Bank (TSX—TD).
But higher interest rates could hurt some stocks
Higher interest rates can hurt utilities and pipelines stocks and REITs (Real Estate Investment Trusts) two ways. First, higher rates make their generous dividends relatively less attractive. This may lead investors to sell income stocks or at least keep new money out of them. Second, utilities, pipelines and REITs need to borrow money for long periods of time. Until a new power plant or pipeline enters service, the companies face construction costs with no offsetting revenue. Also, higher interest rates may make the marginal projects less economically feasible.
Even so, we still have buys on Key utilities and pipeline stocks including Calgary-based Canadian Utilities (TSX—CU), Halifax-based Emera Inc. (TSX—EMA), Calgary-based Enbridge Inc. (TSX—ENB), St. John’s, Newfoundland-based Fortis Inc. (TSX—FTS) and Calgary-based TransCanada Corp. (TSX—TRP).
The Investment Reporter, MPL Communications Inc.
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The Investment Reporter •1/1/17 •