The stock market and commodities markets are searching for direction from forward looking indicators. John Stephenson, president and CEO of Stephenson & Company Capital Management Inc. in Toronto, and a regular contributor to The MoneyLetter, says investors should adopt a cautious tone for the remainder of the year given this global market outlook of uncertainty. But there are some high-yield defensive stocks and high-quality growth stock opportunities for your investment portfolio in the meantime.
Stocks and commodities have been searching for direction from forward looking indicators in October. Months of market unrest have left many investors weary and poorer, but the market is still searching for direction. A bearish September U.S. non-farm payrolls number sent stocks initially lower right after the data was released, but stocks reversed course midway through the session as a rally in crude oil boosted the shares of energy and materials companies.
To some observers, the bearish jobs report was confirmation that the American economy was worse off than they had suspected. U.S. companies were already being hampered by a strong dollar in their overseas operations. Perhaps they were going to be dealt another blow from a weaker American consumer—a once bright spot in the investing landscape. Still others saw the weak September payrolls number as further confirmation that the U.S. Federal Reserve would hold off on raising rates until 2016. Judging from the Fed Funds futures market, many investors think the Fed won’t be in a position to raise rates until March of next year.
Also impacting investor sentiment about the stock market outlook are persistent worries over whether or not China’s remarkable economic growth story can continue uninterrupted under the guidance of its political leaders. China continues to grow, but the sharp slowing of its pace, and the perceived miscues of its leaders over the summer, while handling its stock market and a slight devaluation in its currency, have shaken investor confidence.
So far this year, cash has been king
This difficult macro backdrop has made 2015 a very difficult market for equity investors. Cash has been king this year, something that has rarely occurred over the last 30 years. Only U.S. government bonds have been holding on to slight gains for the year.
Should day traders switch to nights?
Part of what has made 2015 such a frustrating year is the pervasive feeling of helplessness. Despite many investors’ best efforts during the trading day, the market seems to always beat us to the punch. Interesting new research from Bespoke Investment Group has shown that, so far this year, most gains in the S&P 500 Composite Index have been made between 10 a.m. and 11 a.m. Eastern Time. Over multi-year time frames, the overnight period from the prior market close until 10 a.m. ET offers the best returns for investors. In other words, many of the gains occur while investors are not at their trading screens. No wonder many have felt a little out of sorts this year, with the short-term trend for the U.S. stock market constantly being set while most of us are sleeping.
U.S. markets are rebounding
But despite a multitude of worries, stocks in the U.S. recently finished higher for the third week in a row as the initial batch of third-quarter results were broadly well-received by investors. Heading into October, the stock market outlook was for one of the worst quarters for corporate earnings in years. However, so far results, while somewhat uneven, have not deterred investors and most now expect earnings “beats” going forward.
The rise in markets followed the release of lackluster U.S. economic data. That’s not surprising, as this further eroded expectations that the Fed would raise interest rates this year from current ultralow levels. Futures markets are now pricing in just a 27 percent chance of a rate liftoff occurring at the Fed’s December meeting. Recent data showed U.S. industrial production fell to a seasonally adjusted 0.2 per cent in September from a month earlier, the latest sign of a factory slowdown.
Trend reversal or relief rally?
This past summer was pretty scary for many investors, with U.S. stocks plunging 11 per cent in August before staging a modest recovery. Now some big money investors are now starting to see fresh value and wading into beaten-up energy stocks and financials, as well as dividend-paying blue chips. And while this may be just a relief rally from oversold levels, I for one am not complaining.
Oil market outlook—moving higher
Also powering stocks higher is oil. Crude prices have started rising lately, buoyed by lower drilling activity in the U.S., draw downs on gasoline and diesel inventories, and by more speculation about Russia and major oil exporters meeting about supply cuts. That’s been good news for energy companies, broadly, who are benefiting from rising commodity prices and improving investor sentiment.
Masters of decline
However, there is one part of the U.S. energy sector that is still dealing with a sharp selloff. These are the master limited partnerships, whose decline has outpaced the fall in oil prices. Energy pipeline and storage companies were one of the hottest investments on the Street, offering steadily higher payouts, tax benefits and insulation from wild swings in oil prices.
The multi-year boom in U.S. oil production fuelled the proliferation of master limited partnerships. These companies, which transport, store, produce and refine energy, have been passing on the bulk of their earnings to shareholders. For a time, income-starved investors flocked to the sector, lured by these companies’ assurances of steady payout increases and their tax advantages.
But with oil production falling, the need for pipelines is declining, and the sector’s multi-year expansion and the previous steady growth in its dividend-like payments are now under threat. Investors have begun to question the long-term growth forecasts of not only the master limited partnerships’ dividends, but for their ability to grow their assets.
U.S. crude output was down six per cent in early October from a recent high in late June, while the number of rigs drilling for crude has fallen sharply. These developments are prompting fears that further output declines are on the horizon.
What I recommend
The market will likely push higher over the coming months. However, there is no end in sight to the ongoing debate about global growth, which has plagued markets for the past two months and will, in turn, keep markets on edge. Until the Fed finally goes ahead and starts raising rates, the uncertainty surrounding the timing of a rate hike will likely hang over the market. This will perpetuate, for the foreseeable future, the “Will they or won’t they?” debate that has kept market uncertainty at a high.
Given all the uncertainty, the best approach to a market outlook such as this is to look toward high-yielding, defensive stocks and high-quality growth companies for the majority of your investment portfolio.
Veresen: Value and dividend are both attractive
One name I like in the energy infrastructure space is Veresen Inc. (TSX─VSN). The company owns and operates energy infrastructure assets, including pipeline transportation, natural gas liquids and power.
In addition, Veresen is working on the Jordan Cove Project, an LNG export terminal based in Oregon. While there is some uncertainty in whether or not Veresen will get the go-ahead for this project, investors aren’t paying for it in the stock. I believe that the base project, if approved, could add $9 to $10 a share on a present value basis if it were to proceed. A decision on Jordan Cove’s viability should be forthcoming by the end of March 2016 at the latest.
At current stock prices, Veresen offers a current yield on the dividend of 8.2 per cent, which the company believes is safe. Management recently defended the current dividend of a $1 a share as a long-term strategic decision. I have a buy rating and a 12-month price target of $20 a share on Veresen.
Pembina Pipeline: Strong growth profile should support healthy dividend hikes
Another stock that fits the bill is Pembina Pipeline Corp. (TSX─PPL), another energy infrastructure company that transports, stores and markets petroleum products. Pembina has $6 billion of secured growth projects, providing visible cash flow growth into 2018. The vast majority of these products are underpinned by long-term fee-based contracts that are expected to add $700 million to $1 billion of EBITDA. (EBITDA is earnings before interest, taxes, depreciation and amortization.) They will also serve to reduce the commodity-price exposure of the company toward 15 per cent from 30 per cent currently.
The current dividend yield is 5.3 per cent and the company has the potential to increase the dividend at a 10 per cent compounded annual growth rate over the next three years. I have a buy rating and a 12-month price target of $45 a share on Pembina Pipeline.
RioCan: Canada’s largest REIT offers attractive, rock-solid income
Another stable income name that should do well during this period of uncertain stock market outlook is RioCan Real Estate Investment Trust (TSX─REI.UN), Canada’s largest REIT. RioCan owns interests in a portfolio of approximately 350 shopping centres (including 15 under development) across North America, encompassing roughly 54 million square feet. RioCan offers scale, diversification, and the ability to attract and retain the highest caliber of talent, not to mention significant access to capital. It also provides investors with ample liquidity.
RioCan’s monthly distribution of $0.1175 a unit, or $1.41 a year, is rock-solid and the current yield is 5.4 per cent. I have a buy rating and a 12-month price target of $31 a share on RioCan REIT.
Focus on quality
Investors should adopt a cautious tone for the remainder of the year given the uncertainty in the global investing climate. It may seem paradoxical, but the current malaise in the stock market is a healthy and needed correction—not a harbinger of darker days. While there appears to be a more optimistic tone in the market, I’m easing back into some high quality names and trying to add to my positions on pullbacks. It remains important not to simply chase stocks during regular market hours.
The MoneyLetter, MPL Communications Inc.
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