A Comment -- General Comments From an Expert (A Commentary)

Maximum percentage of one equity in a portfolio? He believes in selling losers to minimize losses and let the winners run. For some reason a lot of investors tend to do the opposite. If the stock gets up to about 10% of a portfolio, he’ll cut it back to a 5%, as long as he considers the fundamentals still good.

How is South Korea’s Hanjin shipping going to affect Canadian Pacific (CP-T) and Canadian National (CNR-T)? Hanjin just declared bankruptcy and it has ships in the water that are languishing. Some of its cargo will eventually work its way in, and some of it could go bad. This will affect these 2 companies to a small degree. Eventually those products will come in and will move.

Markets. He does software modeling for institutional investors. Utilities are probably still okay, but generally speaking the market is getting richer and richer. Materials and Energy are at premiums to invested capital or book value. Look for stocks with a low premium. Oil stocks look inexpensive to him. He does not try to predict where oil is going.

Dividend Stocks. With interest rates having come down so much, many investors are looking at low risk dividend paying stocks as an alternative to buying bonds, which offer such a low return. An analysis of the S&P 500 on the difference of the price earning ratio between high beta and low beta stocks shows that the difference is very, very wide, indicating that defensive stocks are quite expensive now. Interest rates in North America have been driven mostly by what is happening outside of North America, especially Europe and Japan. Most Central Banks are doing everything they can to stimulate growth, and it is not really working very well. In the US, they are trying to raise rates and normalize monetary policy, but it is very difficult to achieve in a world with such sluggish growth. If rates keep coming down and the monetary policy keeps loosening globally, it is going to continue to drive asset valuations higher, but when looking at multiples at about 19X on the S&P 500, it is becoming a bit challenging to see a lot more upside.

Criteria for dividend growth stocks? The first thing he cares about is a strong business model. You want one that is durable, gives good visibility, and good re-investment potential. When a company generates strong cash flow, you want them to be able to deploy those cash flows with good returns. A cash flow metric is very important, because that is what dictates the capital return policy. Free cash flow divided by the stock price is a key metric for him.

Markets. There are some dividend names he is a little cautious on. There is a bit of complacency out there, particularly in a number of some of the expensive defensives. He builds a portfolio on a bottoms up basis, making sure that everything he owns he truly likes. He would rather own management teams that can be opportunistic and do things when it makes sense. A lot of valuations are not low, and now is not the time for companies to be buying back aggressive amounts of stock in many cases. A very important point; DRIP programs at the end of the day are simply issuing more shares. It is very important to not just look at yield, but look for companies that are giving a better total yield, not just a high dividend yield.

Market. The Bank of Canada governor indicated they are not changing interest rates, still staying at .5%. He also made comments about the economy. It is a slow growth environment, but getting better. What wasn’t said was that Canada wants to see what the federal reserve does, and react to that. Although we may look to the central bankers globally, history tells us that they are as wrong as any of us. It is a very, very difficult thing to get ahead of the curve. Central bankers, for the most of the time, tend to be reactive. This is a very, very slow growth environment, which will take less pressure off the Cdn$, because the US will not be raising interest rates as aggressively. We are left with a slow growth environment, and we have to look for companies that have a catalyst, something that is unique to them that allows them to grow at a faster rate than their own historical performance, their peer group, and the economy as a whole. If you find that, along with proper pricing, then you settle into a good portfolio and be patient.

Oil. There is a risk that we will see lower oil prices over the next few months. There is the summer driving season, which is a strong period of demand. Then you go into a shoulder season of September, October and November, and demand falls by 1-1.5 million barrels a day worldwide, (maybe half that in the US). In 2014, we fell from $100 down to $50. In 2015, we went from $51 down to $35. He thinks the decline will be potentially down into the low $30. There was a 2.3 million-barrel production increase last week in crude stocks, 4.5 million-barrel in overall stock, and the week before it was 2.6. There should not be inventory building now, it should only start the 2^nd week of September. He is bearish on oil prices for the next quarter.

Markets. He is meeting a lot of super cautious people that think the end of the world is coming. When the market is undervalued and the individual investor is afraid to put their money to work, private equity steps up, the corporations step up and jump into the void and take advantage of that. The last time we were at these valuations, interest rates were 5% higher than they are now. If you apply Capital Asset Pricing Models (CAPM), multiples should actually be quite a bit higher. Because of that, you could make that the market is undervalued. Companies are looking at this and can borrow money at very low interest rates to make undervalued acquisitions. Investors don’t have to Buy the market. There are a bunch of stocks that are trading at single digit PEs, so you are not paying up for the stuff. It people are willing to spend the time, dig and find the value they can outperform the market over the long-term.

Market. Thinks the market is still positioning for rate hikes this year and that the Fed is going to do their best to get one hike in this year. The US$ is the one chart to watch, because it is such an important indicator of the global macro trend. If the US$ is going to strengthen like it did in advance of the rate hike, that could put pressure on crude oil, commodities and Canada. We have reached peak dovishness in terms of interest rates. That has pushed all the bond look-alikes, utilities, REITs, telcos, etc. to very high valuations. His biggest concern is more sector risk. When valuing stocks, he looks for 3 things; price momentum, valuation and volatility, and wants to buy stocks that have the best combination of those 3.

REITS. The sector is up 16% year to date. August was a bit of a dip. There is a fair amount of interest coming into the sector. In September REITs will have their own sector and won’t be under “Financials” any more, and he thinks there will be a bit more interest. Any surprises, of rising rates, is going to put negative pressure on the REIT sector. However, if there was a dip, he would be buying into it.

Markets. He does not focus on dividend yield so much as on dividend growth. The US equity market has been in a profit recession for 5 quarters. First quarter this year was the worst quarter for earnings growth. But improvement in earnings for the fourth quarter is largely priced in. Telecom, utilities, energy and materials are the top sectors. He is typically in consumer staples, consumer discretionary and financials. There is a real risk in stocks with a high dividend yield.

Economy. The manufacturing number out of the US was kind of weak, and then all of a sudden people began to think maybe interest rates would not be raised in September or December. Every single data point seems to switch the market. The Fed is trying to fight unemployment and inflation. Their employment looks like it is at pretty good levels, and inflation is nonexistent. If we start to see wage inflation, that could be the impetus to put pressure on rising rates. Food in the US is at the lowest prices in years so you have food deflation. Energy prices are at low-level’s also, so the US consumer should be spending lots of money. Portfolio managers globally are not earning their returns in fixed income, so that is why people are going into stocks.

Bank preferreds? He would rather buy the stocks rather than the preferreds. There is no point in buying preferred shares because you don’t get any of the potential upside. However, he would have no problem in buying any of the big 6 banks.

Market. Doesn’t believe the US Federal Reserve will pull the trigger on an interest rate increase in September. She doesn’t expect a rate rise until the November or December meetings. We are still running well below inflation targets. The big number is going to be the jobs report this Friday. Because the rate increase has been expected for so long, if it happens, she wouldn’t expect as much of a shock or pullback in the market. In the 4^th quarter, she is expecting double digit earnings gains.