For 2014, market momentum and technological innovation will give world-class Canadian companies a solid base.
This year, more than ever, we’ve been reminded of Warren Buffett’s description of investing being simple but not easy!
The usually treacherous months of September-October, which also marked the fifth anniversary of the Lehman Brothers failure and the Great Recession and market crash of 2008-09, came and went – but with a very different twist.
Instead of the usual storms, investors were treated to extraordinary political soap operas in Washington – and Ottawa. The result: Stock markets in the U.S. soaring to record new peaks and in Canada to welcome two-year highs!
Another simple-but-not-easy reminder has been the need for investors to try to see through market “noise,” especially when it rises to crescendo levels, as it has recently – quantitative easing, tapering, interest rates, the debt ceiling, politics, Senate scandal, the Eurozone, China, Abenomics and Syria, to name a few.
We’re also reminded of the advice of Benjamin Graham, that you will be right if your facts and reasoning are correct. There’s also John Maynard Keynes: “When the facts change, I change; what do you do?” As 2014 and the future come into view, could this be an opportune time to once again assess the facts and weigh investment markets – we think it definitely could?
If there was any common ground in Washington’s latest debt-ceiling fiasco it has been the near-unanimous view that this type of political grandstanding and the partial shutting down of government was no way to run a country. Particularly when that country makes up the world’s largest economy and its currency is de facto the world currency.
Doubly sobering is a dysfunctional Congress that has not passed a normal budget since the global financial crisis of 2008-09, instead lurching from one eleventh hour compromise to the next – the latest patched-over deal to expire in February 2014!
Kishore Mahbubani, Dean of the Lee Kuan Yew School of Public Policy in Singapore, summarizes this concern expressively: “People always looked up to America as the best-run country, the most reasonable, the most sensible. And now people are asking ‘Can America manage itself and what are the implications for us if it can’t?”
Notwithstanding their stellar recovery, confidence and trust remain conspicuously lacking in the U.S. investment markets.
Yet in Asia, a necessarily slowing China, on course to become the world’s largest economy within the next two decades, could be making discernible progress in its momentous transition to an economy built on a rising billion-person consumer sector.
And in Japan, the benchmark Nikkei is running away with this year’s stock market stakes – up 38 per cent to the end of October!
Hopefully it is facts and signals like these that are nullifying the political gerrymandering and that buoyant stock markets everywhere are picking up on.
In late-October, the National Debt Clock in midtown Manhattan was ticking away at $17 trillion, equivalent to $148,000 per American family. We remember thinking, tongue-in-cheek, thank goodness Congress had lifted the previous $16.7 trillion ceiling just in time!
A recovering economy could no doubt start bringing a ratio equivalent to the entire U.S. GDP back down once again. But seldom if ever before have interest rates been kept at such sustained and artificially low levels.
Late May’s sudden hundred basis point surge in U.S. Treasury 10-year yields to the 2.8 per cent level provided a foretaste of what could be in store when the lid eventually – and inevitably – blows off central bank-engineered interest rates. In one single day the correction in frenzied bond markets was tantamount to a 600 point drop on the Dow.
Thankfully, the debt burden is not nearly as onerous in Canada so pre-occupied by Senate spending abuses and possible prime ministerial cover-up that the signing of a momentous free trade agreement with the European Union has been all but ignored.
Furthermore, our national debt-to-GDP ratio of 30 per cent compares still more favourably given Finance Minister Flaherty’s confident – and credible – expectation of Canada’s federal budget being back in balance by 2015 from a 2.9 per cent deficit currently.
But, not even a fiscally-sounder Canada is immune from chain reaction risk as the U.S. and the world at large finally awaken to the perils of an extremely addictive and difficult-to-shake debt habit.
History tells us that when debt keeps being piled on debt, in the process adding ever more leverage, it usually doesn’t end well.
A first big rehabilitative step must be the resumption of economic growth. Not the anemic government and central bank infused growth of recent years, but true job and wealth-creating growth.
Supportive government fiscal and regulatory policies would help, as would trusted and well capitalized banking systems capable of facilitating credit and liquidity.
However, there is an ultimate driver of direly-needed economic recovery that could already be in place in the form of cheap energy and productivity in combination on an unprecedented global playing field!
We’ve written previously of the energy revolution sweeping the world as shale oil and natural gas are found and harnessed in ever-increasing abundance.
In particular, there is natural gas, a much cleaner and less dangerous fuel to transport than oil in the conversion of coal-fired industries and the provision of cheaper feedstocks for entire new industries. There is also the race to supply hungry Asian markets with natural gas in liquid (NGL) form.
Add ever-cheaper energy feedstocks to human innovation reflected in today’s breathtaking technological and productivity advances and imagine the contribution to debt-trapped economies.
Now, what if today’s technological advantage were to bring the next quantum leg-up to economies built on cheap, readily-transportable energy feed stock? Truly the sky could be the limit!
No doubt too, the competition would be fierce in a world in which globalization and free trade keep escalating in all their “disruptive and historic glory.” But in a global combination like this could lie the escape from today’s debt stranglehold. The investment rewards would be immense.
If you cut through the market noise, Canada (the backyard we know best) compares very favourably against a thrilling global background. Surprisingly, there’s both comfort and encouragement in a wide range of world-class Canadian investments.
Proxies we continue to champion are our diversified Canadian 6-Paks covering a full range of superior Canadian investment potential, the Equity 6-Pak focused more on growth, the Dividend 6-Pak on growing income return.
To the end of October, the Canadian Equity 6-Pak, comprising Bank of Nova Scotia, Brookfield Asset Management, Canadian Pacific Railway, Enbridge Inc., EnCana Corp/Cenovus Energy (half allotments) and Thomson Reuters, returned 20.2 per cent.
The return on the Canadian Dividend 6-Pak, made up of Artis REIT, Bank of Montreal, BCE Inc, Inter Pipeline L P., Power Corporation of Canada and TransAlta Corp., was a lower but nonetheless credible 12.7 per cent that includes a growing dividend yield of 5.2 per cent – no slouch in an era of prolonged low interest rates.
By comparison, the year-to-date return on the benchmark S&P/TSX Composite Index was in the order of 10 per cent.
Key in both 6-Pak approaches is the need to keep individual dollar weights more or less equal, by regularly rebalancing. That is, if the fundamentals justify their continuing inclusion; and recognizing that changes are periodically required.
Already apparent in the Equity 6-Pak is the need for trimming the holdings in Canadian Pacific Railway and likely also Brookfield Asset Management, this predominantly in favour of my long-suffering duo of EnCana Corp. and Cenovus Energy.
What a pleasing surprise the forcible changes of a year ago are bringing at CP Rail, as the investor love affair with railroads continues apace. New CEO Hunter Harrison is effecting dramatic improvement in CP’s operating cost ratio and following from it the company’s bottom line.
Oil-by-rail is a lucrative new bonus as President Obama keeps dithering over the Keystone XL pipeline and railroads fill the void by transporting Canadian oilsands bitumen across the border to waiting Gulf refineries at a rate of 200,000 plus barrels a day. Projected to double in volume by the end of next year.
We are hopeful too that radical changes at EnCana are beginning to bear similar fruit as Doug Suttles, a strong new chief executive, refocuses Canada’s largest oil and gas company on the areas where it is strongest – and the feedstock demand for natural gas and natural gas liquids keeps on surging.
Few natural gas companies have more to offer than EnCana, but not all at once, even if its dividend has had to be cut in favour of higher-rated priorities.
The EnCana dividend could well be offset by Cenovus Energy, with its highly-rated oilsands operations and steam-assisted gravity drainage (SAGD) technology to combine with its downstream Conoco-Phillips’ joint ventures.
We like the description of Cenovus as a ‘best-in-class’ Canadian oilsands operator and we continue to recommend EnCana and Cenovus as a unique duo to be held in a 2-to-1 ratio for the rewards we are convinced 2014 is going to bring.
While Brookfield Asset Management may need to be trimmed, there should be no doubt about this $180 billion Canadian world leader in power, property, infrastructure and private equity.
We are also attracted by Brookfield Property Partners LP’s (TSX-BPY.UN, $20.00) offer to buy the 49 per cent of Brookfield Office Properties it doesn’t own.
Brookfield’s immense global properties would thereby be consolidated under one platform and an expanded Brookfield Property Partners will have added discounted net asset value attraction to go with a five per cent yield.
In a more evenly balanced Canadian Dividend 6-Pak the weak sister remains TransAlta Corp., which we’re resolved to stick with through its massive transition from a coal to natural gas-fired electricity generation.
Under the 6-Pak discipline we’ll be needing to add more: If Mr. Buffett and Berkshire Hathaway favour TransAlta, we should like it too. In addition, they also like Suncor Energy, which although not a 6-Pak member, remains a long-standing favourite among my Canadian recommendations.
An essential criterion in the accompanying Canadian Dozen (see below) for 2014 is meaningful internationalism.
It’s therefore also a world-class Canadian list to choose from for this all-important reason. Please not all of them, but in selections like these lie superior world-ranking Canadian entities to suit the widest range of investor choice.
OWN, not loan
A year ago, we recommended a lengthy list of worries and “what ifs” be played down in favour of a “contrarily positive” approach to 2013. While it has been “The New Year of Living Dangerously” (U.K. Sunday Times), 2013 has nonetheless turned out surprisingly well for investors.
John Templeton used to explain how bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. No doubt about the euphoria that greeted the new millennium in 2000 or the end-of-the-world pessimism in the spring of 2009. Now we see markets at the “grow on skepticism” phase with plenty of ongoing momentum as well as a convincing new long base to build on.
If we have one over-riding recommendation it is that 2014 will also be a year in which to own, not loan!
Canadian Dozen for 2014
|Bank of Nova Scotia||(BNS)||$63.39||$2.48|
|Canada’s most international bank|
|Brookfield Asset Mgmt.||(BAM.A)||$41.28||$0.60 +|
|Property, dominance, renewable, power, infrastructure, financial|
|Canadian Pacific Railway||(CP)||$149.04||$0.40|
|New leadership, prodigious operating catch-up leverage, oil-by-rail bonus|
|Encana Corp.||(ECA)||$18.68||$0.80 +|
|A refocusing North American natural gas giant|
|Among best in oil sands, SAGD, refinery partnership with Conoco-Phillips|
|Asian controlled, integrated producer and downstream, new mgmt., project diversity|
|Canada’s largest insurer, impressive international (Asia) push|
|Canada’s largest Oil&Gas producer, a cash & dividend machine|
|Diversified integrated mining, export coal, other|
|A premier world bank by every metric|
|Trans Alta Corp.||(TA)||$14.03||$1.16|
|Conversion to natural gas, joint venture with Mid-American Energy|
|Trans Canada Corp.||(TRP)||$46.99||$1.84|
|Transitioning leader, energy transportation and generation, including hydro, nuclear|
|+ U.S. Dollars|