Full episode: Market Call for Tuesday, September 12, 2017
Cameron Hurst, chief investment officer at Equium Capital Management
FOCUS: U.S. equities
REMAIN NEGATIVE ON CANADA
Candidly, we struggle to understand where the Bank of Canada is coming from with back-to-back rate hikes in July and September, not to mention strong market implied odds of another hike before year-end. This easily situates the Bank of Canada as the most aggressive central bank with tightening policy. GDP, among the most backward-looking of economic indicators, has been quite strong for the first half of 2017, the best among developed nations.
Exports (which are tied to a cheap loonie), fixed investment (housing-driven) and consumer spending (debt-driven from housing equitization) were the swing factors.
We know the housing market is being actively cooled by the government, consumers are already over-levered and the higher loonie presents a headwind to exports, not to mention all the problems in the oil patch.
Job growth has also come in above expectations.
Here, we would point to a quality issue with the full-time job losses last month, the worst since the financial crisis (and they were more than made up for with lower-quality part-time employment gains).
Moreover, we remain concerned with oil price risk and NAFTA negotiations that have the potential to be targeted by the Trump administration looking for a political “win."
Aggregating these concerns, and to be clear, we believe the Bank of Canada is in the midst of making a policy error. In turn, this likely means the Canadian dollar is approaching its near-term highs and capital is best shifted abroad.
And remaining true to Equium Capital’s investment process, there has been absolutely no progress made on the technical front either. TSX relative strength just made a fresh and pretty notable low yesterday, offering no silver lining to the shaky fundamentals.
LOOKING FARTHER ABROAD FOR GROWTH
With improved purchasing power for a stronger Canadian dollar, foreign assets have become relatively cheaper and offer significantly better growth prospects.
France continues to screen well in our top-down work, with President Macron introducing legislation on labour reform that’s set to be implemented on September 22. Pushback has been minimal with fewer strikes planned in protest than we’ve seen in the past to more moderate reforms. This type of structural progress, in the context of strong Eurozone growth, keeps us quite positive on France.
India is another interesting geography at present, benefiting from strong demographic and development trends combined with reform and pro-growth measures. Prime Minister Modi is the force behind opening up foreign direct investment, reducing costly fuel subsidies as well as steps towards recapitalizing state-owned banks. As one of the world’s poorest countries, yet most populous countries, there is significant runway for the country to grow at an elevated rate while it catches up with its emerging market peers like China and Brazil.
UTILITIES SELECT SECTOR SPDR FUND (XLU.US)
- Sector: Utilities
- Assets: US$8.04 billion
- Expense Ratio: 0.14%
- 1 Year Absolute: 16.2%
- 1 Year vs Sector: -0.19%
- 1 Year vs S&P500: -1.7%
- Valuation: (Top 10 Holdings)
- Top Line Growth: CY17 +3%, CY18 +4%
- EPS Growth: CY17 +1%, CY18 +6%
- P/E Multiple: CY17 18.9x, CY18 18.2x
Our base case calls for muted inflation over the coming months. Low inflation puts downward pressure on interest rates. Bond proxies (such as utilities) tend to outperform in low rate environments because of the attractive yield they offer. Operating within a regulatory framework gives utilities a clearer growth trajectory and means they have less business risk and more earnings visibility than many other defensive sectors, which can help balance the risks in a portfolio.
Strategic activity remains a key focus across the group with many large players currently exploring potential transactions (Dynegy, NRG Energy, Calpine). Historical M&A in the sector has resulted in substantial synergies equal to 15-75 per cent of the acquired company's operating and maintenance costs.
Renewables’ economics are improving at a rapid rate and we are beginning to see significant deployment plans being laid out by some major players in the XLU (NextEra Energy, Duke Energy, Southern Co). These plans should drive above-average EPS growth due to the large number of incremental investment opportunities.
Notably, utilities are tax exempt and so would not be big beneficiaries of tax reform were it to pass.
Utilities have been one of the best performing sectors year to date with our view on interest rates and the moderate growth environment supporting them for the foreseeable future.
- Sector: Info Tech
- Market Cap: US$243 billion
- 1 Year Absolute: +28.9%
- 1 Year vs Technology: -3.0%
- 1 Year vs S&P500: +11.2%
- Top Line Growth: CY17 +16%, CY18 +10%
- Bottom Line Growth: CY17 +18%, CY18 +15%
- P/E Multiple: CY17 25.9x, CY18 21.8x
As technology and spending patterns evolve, we really like FinTech and payments space in general. Visa bought in Europe so it’s a more complex company now with FX and currency head/tailwinds. Re-organization started last quarter and is helping to modestly reduce the corp tax rate. Management continues to post beat-and-raise quarterly results, and the consistency we really like.
Raised full year net revenue guidance approx. 2 per cent in the July earnings release. Volume trends stable with double-digit year-over-year growth and improvement in cross-border volumes and transactions.
Operating margin came in 66 per cent last quarter; Visa has almost 10 percentage points higher operating margin over the last 12 months versus Mastercard. Visa volumes also remain stronger than Mastercard.
2016 U.S. volumes grew almost 4 percentage points faster than Mastercard due to several major partnership wins.
C2Q’17 EU purchase volumes +9% at Visa versus -3% at Mastercard. C2Q’17 U.S. purchase vols +12% at Visa versus +3% at Mastercard.
You’re getting a couple extra percentage points growth out of Visa at a slightly cheaper valuation. Management focused on capital return, with dividends and share repo equalling 116 per cent of net income last year.
Not cheap, but high-quality franchise with huge moats, big margins and a long growth runway, comfortably justifying the lofty low/mid-20s P/E.
iShares U.S. Aerospace & Defense ETF (ITA.US)
- Sector: Industrial
- Assets: US$4 billion
- Expense Ratio: 0.44%
- 1 Year Absolute: 32.8%
- 1 Year vs Industrials: +13%
- 1 Year vs S&P500: +15%
- Valuation: (Top 10 Holdings)
- Top Line Growth: CY17 +6%, CY18 +6%
- EPS Growth: CY17 +8%, CY18 +10%
- P/E Multiple: CY17 19.8x, CY18 18.8x
Heightened threat environment globally and ongoing strength in aerospace trends support the A&D subsector now and looking forward. Structural trend of increasing security threats globally (North Korea, ISIS).
U.S. defense budget inflecting higher under Trump administration; Republican sweep should make increasing the defense budget easier. Also, increasing international defense sales.
No longer Unipolar system with U.S. as biggest power, as we're seeing emergence of China and Russia as military powers. Pressure on NATO allies to meet 2 per cent GDP requirement ($52 billion).
Ongoing strength aero cycle – Q2 results surprised to the upside. Air traffic growth remains strong. After market driving demand. Weak dollar a positive for Aero.
Has been a good performer but believe there is room to run given the structural story.
PAST PICKS: APRIL 6, 2017
- Then: $141.17
- Now: $172.80
- Return: 22.40%
- Total return: 22.40%
CBS CORP. (CBS.N)
- Then: $68.80
- Now: $58.40
- Return: -15.21%
- Total return: -14.71%
INGERSOLL-RAND PLC (IR.N)
- Then: $82.67
- Now: $90.10
- Return: 8.98%
- Total return: 10.06%
TOTAL RETURN AVERAGE: 5.91%