John Stephenson, portfolio manager and president of Toronto-based Stephenson & Company Capital Management Inc., says the recent dramatic decline in the greenback is unlikely to be sustained for an extended period of time and an upward trajectory of the greenback is likely to be the dominant theme for the balance of the year. Investors should begin to accumulate shares of these U.S. stocks on any weakness in the market outlook.
Markets have an uncanny habit of confounding the majority view much of the time. The consensus over the last few months was that it was best to short the euro and go long on European stocks, particularly German equities. It was a good theory; however, a wildly gyrating U.S. dollar has laid those plans to waste. The greenback finally ended the month of April on an up note, but only after it dropped to a two-month low against the euro, as evidence mounted of a slowing U.S. economy.
A rebound in crude oil, together with a string of disappointing economic data points, conspired to send the U.S. dollar down sharply against a number of major currencies. During the month of April, the greenback slumped 6.64 per cent against the Norwegian krone, tumbled 4.50 per cent against the Canadian dollar and fell 4.28 per cent against the euro.
The dollar index, a gauge of the currency’s value against a basket of peers declined to 94.6 during April—its lowest level since late February—and down 5.8 per cent from a 12-year high that it hit in March of this year.
Slouching dollar, strutting euro: The European fallout
Recently, European stocks have come under pressure from a strengthening euro. In the last week of April, Germany’s Xetra DAX Index fell three per cent, while the pan-European FTSEurofirst 300 Index suffered its first monthly decline of 2015.
But it was the currency and fixed income markets that suffered the most extreme price action over the last week of trading in April, as the U.S. Federal Reserve acknowledged that the American economy had lost momentum and data out of the euro zone signaled that the region’s bout with deflation had ended—bolstering recovery hopes.
Muted U.S. growth: Due to ‘transitory factors’?
Further signs of muted American growth emerged in late April, as the Institute for Supply Management’s manufacturing index held steady at a two-year low of 51.5 for April. The data came on the heels of Gross Domestic Product (or GDP) numbers that showed a paltry rise of 0.2 per cent in first quarter growth for the U.S. economy.
Not only was this figure a huge disappointment, it appears to have come with an accompanying build-up in inventories. The latter will temper demand for production. Observers responded to these developments by scaling back their market outlook for U.S. growth and pushing back their expectations for a Fed rate hike.
At its mid-week policy meeting in late April, the U.S. Federal Reserve acknowledged the weakness in the economy, but said this reflected “transitory factors” and that the soft patch would be short-lived.
Nevertheless, the dollar was hard hit by the latest batch of GDP figures and the month-long selloff of the greenback continued through to the end of April.
Now, much turns on whether the U.S. economy has experienced a temporary soft patch, or faces a further run of lackluster data that leaves the central bank on hold, with the potential for triggering a far larger shakeout across markets, led by the dollar.
A reversal of fortune . . . and who it benefits
After heady market chatter in mid-March of parity between the euro and the dollar, the greenback’s reversal has come at a vulnerable juncture—just at the point when many investors were betting on further strength. The worry is that the dollar could fall a lot further as dollar bulls unwind their bets, sparking a further rise in the euro that tightens financial conditions in the euro zone.
That may be a welcome respite for those for whom the strong dollar has been especially painful—among them American exporters and non-U.S. corporations holding large dollar-denominated debt, particularly in emerging markets.
While the first quarter economic data was disappointing, the American economy is still poised for a 3.5 per cent or greater rise in the second quarter. Despite a fairly consistent trend of economic outperformance over the last year, investors remain cautious on the U.S. stock market outlook—with the performance of the S&P 500 composite index trailing behind that of most other major stock indexes.
Watch for the U.S. economy and dollar to rebound
In my view, the most likely scenario is not a slumping American economy and a surging euro zone, but rather the opposite. The fact remains that the United States has been outperforming almost every other major economic zone of late and while the U.S. dollar’s weakness may continue through the next quarter, the upward trajectory of the greenback is likely to remain the dominant theme for the balance of the year. I, for one, remain bullish on the U.S. dollar.
What I Recommend
The best performing sector of the market last month was energy, as West Texas Intermediate (WTI) —the U.S. benchmark for crude oil—moved from $49.60 per barrel at the beginning of the month to $59.63 per barrel: a gain of 25.3 per cent. But energy investors may be getting ahead of themselves, as the S&P/TSX Energy sub-index trades at a forward price/earnings ratio of 44 times versus the broader market, which is trading at 19.0 times 2015 estimated earnings.
Strong U.S. fundamentals versus Canadian optimism
The S&P/TSX composite index’s April rally appeared to be driven by low-quality factors such as analysts’ optimism about the potential for an oil price recovery, yet this underestimates how long oil prices could remain at current levels. With no improvement in the broad underlying fundamentals for the S&P/TSX, I am wading back into the U.S. stock market, believing that the superior fundamentals there, coupled with a likely appreciation of the U.S. dollar versus the Canadian dollar, will deliver superior returns.
Given my bullish American market outlook, I believe that investors should begin to accumulate shares on any market weakness. The dramatic decline in the greenback is unlikely to be sustained for an extended period of time and the superior fundamentals of the U.S. economy make it an attractive place for Canadian investors.
Actavis: Near double-digit revenue to drive EPS growth
One healthcare stock I really like is Actavis plc (NYSE-ACT). A global, integrated specialty pharmaceutical company, Actavis is focused on developing, manufacturing and distributing generics, branded generics, established brands and non-prescription “over-the-counter” products. It is the third-largest manufacturer of generic drugs in the U.S. and one of the top five players in nearly 20 international markets.
In my view, Actavis can grow revenue at close to 10 per cent a year, driving EPS growth in the mid-teens over the medium term. I believe the stock should move higher on greater visibility of its core business—and once its operations are further stabilized following its recent merger with Allergan, Inc. I have a buy recommendation on the stock and a 12-month target price of $365.
Brookdale Senior Living: A ‘pure play’ on demographics
Another U.S. healthcare stock that I like is Brookdale Senior Living, Inc. (NYSE-BKD) a national leader in senior living. It has four basic offerings for seniors: independent living, assisted-living, dementia care and skilled nursing.
The senior housing/assisted living industry is a “pure play” on the aging of the U.S. population, with minimal exposure to government reimbursement.
There is significant operating leverage in the existing portfolio, as an uptick in the residential housing market or general consumer confidence could help improve occupancy, which would carry high incremental margins and significant leverage. As well, there remains a possible spin-out of the company’s real estate assets that could provide a significant catalyst for the share price. I have a buy recommendation on the stock and a 12-month target price of $44.
Blackstone: Top pick among alternative asset managers
In a rising stock market, shares of alternative investments (hedge funds, real estate and private equity) are poised for higher highs. My favourite name in the alternative asset space is The Blackstone Group L.P. (NYSE-BX).
Blackstone has a deep bench of talent, a focus on reinventing its business constantly, a global footprint, and the ability to generate strong fund performance and raise more capital than its competitors. With net internal rates of return north of 15 per cent since inception in private equity, credit and real estate, I see multiple levers to generate income.
Over the past two years, Blackstone has raised more than $90 billion of capital, which is more than the total capital raised by its four closest competitors combined. Innovation is a key driver, with more than $76 billion of assets being raised in entirely new strategies since its initial public offering. I have a buy recommendation on the stock and a 12-month target price of $50.
Weak dollar, strong dollar: Two routes to rising U.S. stocks
For U.S. stocks, the market outlook remains very bright. If the U.S. dollar weakens, corporate earnings that had been hampered in previous quarters, should rebound. If the greenback regains its strength and it turns out that the Fed was right in its assessment that “transitory factors” were to blame for the weakness, a rebound in U.S. equities is also in the offing.
The MoneyLetter, MPL Communications Inc.
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The MoneyLetter •5/20/15 •