Outlook 2018
Monday, 15 January 2018

The very long term

As we have pointed out in previous Quarterly Market Outlooks, the unprecedented liquidity injection by the developed world’s major central banks has made short term market forecasting very difficult. We, therefore, thought it would be helpful to update our views as to where North American markets in general and the U.S. market in particular might be situated in a longer term perspective.

As regular readers of our Strategy Notes will know, we have always been interested in market cycles. We divide these into cyclical and secular cycles. On average, secular uptrends comprise several four to 4.5 year cycles and can last anywhere from 10 to 30 years. Over the last 120 years, there have been four secular bull markets. The first took 13 years from 1896 to 1909 and saw the Dow Jones Industrial Index gain over 200%. The second was in the 1920’s (1920 to 1929) and resulted in a 300% gain. The third lasted 30 years (1942-1972) and resulted in a gain of almost 800%. The fourth secular bull market was the biggest of the four and saw the DJII gain almost 1400% (from 1982 to 2000).

Secular downtrends tend to be shorter than secular uptrends – roughly 12 years on average versus 18.5 years for the average secular bull market – although the current secular bear market has lasted 17 years. In contrast, compared to the normal four to 4.5 year cycle, the current cyclical bull market has lasted almost nine years from its inception in March 2009, making it the second longest in history. Cyclical bull markets do not die of old age. They normally end as a result of a recession (9 out of the last 10 times in terms of the US market). The extended cyclical bull market owes much of its unusual length to the extraordinary monetary measures taken since 2009 by the Federal Reserve Board.

The good news as we expand on in the section below in regards to the shorter term market outlook is that we do not currently see an imminent risk of a recession ending the bull market over the next 12 months unless there is a major unexpected exogenous shock to the U.S. economy. In fact, in Q4 we completed our regular semi-annual interviews with the major Canadian banks (as well as the rest of the companies in our equity universe). One of the questions, we have asked the bank CFO’s we have interviewed is when is the earliest they currently see (from interactions with their clients and talking to their Economics departments) as  a possibility for a North American recession – again barring an exogenous event. The personal view of one of the CFO’s who also was previously in charge of Risk for the bank was “not until at least 2019”. Although this cycle is “long in the tooth”, the moderate recovery in U.S. GDP would likely result in a drawn out cycle. In sum, it is still our view that we will see one more cyclical bear market before the current secular bear terminates.

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The long term outlook for dividend growth stocks in a rising interest rate environment
Monday, 18 December 2017

Stock Market Outlook

In our recent Strategy Notes, we said that we were hopeful that we could see some very satisfactory gains over the next year in the TSX since we viewed our previous target of 16,000 for the TSX as very conservative as it was based on an oil price in the low $50’s. Our conviction is growing stronger that global oil inventories will fall below their five-year average by the middle of 2018. If this proves to be the case, the oil price would handily surpass the $60 level and possibly the $70 level. That would mean, in our view, a TSX target of at least 17,000 in 2018 and a reversion to outperformance by the TSX relative to the S&P 500 such as we enjoyed in 2016 but have not experienced this year.

Several clients have asked us of late about our view that long term interest rates have likely bottomed on a secular basis and wondered whether a rising rate environment would be negative for dividend paying stocks. We contest this view and this Strategy Note will examine the historical data for dividend payers and their performance in a rising rate environment.

The long term outlook for dividend growth stocks in a rising interest rate environment

In our November 1 Strategy Note, we commented on the longer term outlook for interest rates. In sum, we felt that there were various forces at work, which would keep inflation lower than the Fed believed and most investors believed. We concluded that “we do not see a sharp acceleration in inflation in North America as being very likely. Consequently, we suspect that although short and long term rates could rise somewhat, we suspect that the increase will be  lot less than central banks and investors generally believe.” That is still our view. However, what we did not restate then is our previously expressed view that we think it is likely that the 35 year bull market in bonds (and bear market in yields) which started in 1981 is likely over. We peg the bottom of the U.S. 10-year Treasury yield cycle at 1.37% in July 2016. The subsequent rally in rates took the yield to just over 3% last year but it has since declined to a current level of 2.37%.

Several clients have noted that dividend stocks have done exceedingly well since the Financial Crisis and so, if long term interest rates have indeed bottomed, then possibly dividend stocks would not do so well in the coming years, especially if we were embarking on a long term secular bear market in bond prices with rising yields.

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The Energy Sector: Part 2
Monday, 04 December 2017

Stock Market Outlook

In our November 15th Strategy Note, we said that we were hopeful that we could see some very satisfactory gains over the next year in the TSX since we viewed our previous target of 16,000 for the TSX as very conservative as it was based on an oil price in the low $50’s. 

We said that we still believed that global oil inventories were falling rapidly to normal levels. Importantly, Organization of Petroleum Exporting Countries (OPEC) November 30th meeting resulted in agreement to keep current production quotas through all of 2018 with Russia consenting to this nine-month extension.  We would note that an oil price of $60 a barrel appears to be Saudi Arabia’s targeted floor price since they need almost $90 a barrel to balance their budget. Also, there is virtually no political risk premium built into the current price  ( around $58 a barrel) and recent arrests in Saudi Arabia of princes and wealthy individuals suggest that some such premium could well occur.

We also noted in our recent November 15th Note that the recent rise on the oil price to the high $50’s has not been matched by the Canadian oil and gas stocks. That Note – entitled the Energy Sector- reviewed what had been happening in the Canadian oil and gas sector and what we regarded as the potential opportunity that existed.  We also said that we would be spending the following week in Calgary visiting managements of our equity universe located there. In fact, we had a very absorbing five days of interviews with CEO’s and CFO’s. The net result was that we have become even more optimistic on the energy stocks although – as mentioned previously – one would not have guessed it from the continuing poor price action of many of the stocks in the sector. Our findings we will be the subject of this Strategy Note.

The Energy Sector – Part 2

In our previous Note, we stated that the performance of the oil and gas sector in Canada had been a lot worse that in the U.S. outside of some of the major integrateds – in particular Suncor and Canadian Natural Resources. We also learned in Calgary that one of the problems for the intermediate producers has been that those two integrateds plus Enbridge, Pembina Pipeline and TransCanada now account for almost two thirds of the energy index weighting. With this high degree of concentration, a number of institutions had concentrated their holdings in these five stocks – in effect becoming closet indexers – to the detriment of the intermediate producers whose weightings in their portfolios had suffered significant cuts.

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