U.S. defence spending could pump up CAE

Columnist Edward Gardiner looks at the uncertainties surrounding NAFTA negotiations, the U.S. budget and events in Europe. He’s encouraged enough to recommend holding pipelines, oil and gas stocks and automotive manufacturing stocks, but limits his new buying advice to ‘paper’ gold stocks and aerospace and defence training simulator manufacturer CAE Inc.

U.S. President Donald Trump’s inauguration has come and gone, and the world neither exploded nor collapsed into chaos. In fact, the financial markets seem quite pleased about it. This market exuberance seems a bit too much for me. I still expect a correction later in the year (say around the fourth quarter).

But very few of the executive orders Mr. Trump has signed so far will have a serious impact on Canada.

TransCanada Corp. (TSX—TRP; NYSE—TRP) has been encouraged to re-file its application for the Keystone XL pipeline; talk of a 20-per-cent surtax at the border on goods exported to the U.S. seems (with the exception of softwood lumber) to be limited to goods from Mexico; and American businessmen are impressing on the president the close integration of American and Canadian companies in several fields (notably the auto industry’s manufacturing stocks).

Will NAFTA be tweaked or overhauled?

The only major area of concern so far is the North American Free Trade Agreement (NAFTA). It remains to be seen whether it faces some minor tweaking or a major overhaul. In either case—and somewhat to my surprise—Canadian Prime Minister Justin Trudeau has done a good job of dealing with the uncertainty.

He’s got lobbyists in place in Washington and, I expect, negotiating teams set up and ready to go on any sector Mr. Trump wants to start on.

Unfortunately, Mr. Trump seems to be one of those people who think ‘negotiations’ invariably involve a winner and a loser. The concept of a win-win outcome is beyond his comprehension.

I’ve dealt with people like that in the past, and sometimes you just have to walk away. Everybody loses in a case like that. Even if an agreement is reached, it rarely lasts very long. The party who feels wronged will always be looking for an out, or a new partner.

It would be a shame if that happened to NAFTA after all these years of success. In this regard, Mr. Trump’s actions on softwood lumber may give us a chance to teach him something about co-operation—specifically, if one party refuses to accept a win-win outcome and insists on a win-lose one, the ultimate result may very well turn out to be a lose-lose.

Press reports claim that Mr. Trudeau is considering retaliatory action against some U.S. exports to Canada. He should move forward with that and not back down until Canada and the U.S. can reach a satisfactory long-term agreement on softwood lumber. It may be the only way to preserve NAFTA.

The Canadian government, which ultimately means us taxpayers, may also be on the hook for additional defence spending over the next few years, but that could actually present some investment opportunities.

The U.S. Federal Reserve is finally starting to raise interest rates, something for which I’ve been calling for a few years now. In the short term, that will be good for Canadian exports as the U.S. dollar rises in value; in the longer term, it will help the U.S. economy sop up some of the excess money created by the quantitative easing that has been going on for far too long.

Overall, the American economy seems to be chugging along quite merrily, so we may see further rate increases in the near future.

Mr. Trump’s budget is a typical Republican one, and will, like most others, be watered down by Congress. I don’t see anything in it of great concern to investors. Whether it presents any buying opportunities remains to be seen. It depends on what changes Congress makes.

So, how does this affect the individual Canadian investor? The first, and most obvious, potential investment is TransCanada.

While the invitation to re-file an application for the Keystone XL pipeline looks promising, any conditions to use American construction materials may be a problem.

There may be other conditions that Mr. Trump has in mind that he hasn’t identified yet. In short, it’s a bit too early to invest in TransCanada (although if you already have some shares, by all means hold on to them). Other pipeline projects could see some new life breathed into them as well.

Oil and gas, some manufacturing stocks may do well

In terms of defence spending, one Canadian company that comes to mind is CAE Inc. (TSX—CAE; NYSE—CAE). Its civilian-based operations look profitable as well.

All in all, CAE looks like a safe bet even if Canada manages to duck a large increase in overall defence expenditures. The major U.S. firms in this area are also worth looking at (although I don’t focus on U.S. stocks).

As for Canadian manufacturing stocks, it depends on the industry and how closely they are linked to U.S. firms. As noted above, the automotive sector looks safe. Firms that make products that are in direct competition with American companies may not fare so well.

Mr. Trump’s ‘America first’ policy and his proposed U.S. content requirements may pose serious problems for such companies.

The oil and gas sector also appears attractive (finally). Prices are starting to rise and companies are considering resuming exploration. As with pipelines, it may be too soon to rush out and invest, but hold on to what you’ve got and be ready to jump in when things start to move.

At the risk of sounding like an economist, on the other hand, the world consists of more than Canada and the U.S.

European politics will affect us too

Brexit, and the strength of the nationalist movements in other European countries, will undoubtedly cause disruptions to the world economy. So too will Russia’s adventures in Eastern Europe and the Middle East. These cannot be ignored.

While Greece is no longer making headlines, its economic problems have not gone away. Other European countries such as Italy, Spain and Portugal are at risk as well, although their problems are not as serious as those of Greece.

As a precaution against all this, you should probably hold some gold in your portfolio. It doesn’t have to be actual bullion; ‘paper’ gold, such as that offered by Central Fund of Canada Ltd. (TSX—CEF.A) or Royal Canadian Mint (TSX—MNT), is perfectly reasonable. Don’t put a lot of money into it; perhaps no more than five per cent or so of your portfolio, but it would be a good insurance policy.

In short, everything is still up in the air. Mr. Trump’s governance-by-Twitter approach to running the U.S. is something new. No one seems to know how to react to it, and no one really knows what is going to happen next.

The best you can do is keep your head down and your options open.

T. Edward Gardiner, a Bell Canada retiree, is a keen observer of the markets who lives in Ottawa.

This is an edited version of an article that was originally published for subscribers in the May 26, 2017, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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