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

Markets. The reaction to what has happened in China is excessive. We have seen a huge draw down in earnings expectations in the US as the year has gone on. Earnings are now looking like they will be down this year. This decade, US stocks have been the best place to be. About 45% of his clients’ investments are in the US. The key to selecting US equities is to look at large cap, battleship type blue chips with most of their revenues in the US.

Markets. The market is waiting for the Fed to decide on interest rates on Thursday. In the absence of anything positive, the market will sort of dip a little. We are at a level where the market looks to be value, and there is also seasonality. He is hoping that they raise rates to 0.25% which will take the volatility. The initial reaction for a half hour or a day might be negative, but after that it would be positive through to the end of the year. If they don’t raise rates, as long as they are extremely clear that they are going to shortly, that is still okay, but not as bullish. Looking at non-resource, this correction has provided value for lots of things. You have to be selective, but there is value both by group and by stock.

Markets. You have to be careful in the Canadian landscape. In the last 5-6 years many companies have had excessive amounts of yields being generated, but have leveraged the balance sheet in order to deliver that yield. He looks for companies that have good free cash flow and gives some of that cash flow back to investors and reinvesting some of it into the business. Currently is seeing a lot of value in that part of the market. When looking at indices that are pure yield, they are down significantly more than the broader market, so he is seeing value in the yield part of the market. Thinks Canada is a sale that is going on. There are no US investors buying the Canadian market. Banks have been under pressure because people are trying to short the real estate market, real estate has been under pressure because Americans think it is overvalued, energy has been a headwind, and there haven’t been many Americans that want to take currency risk here. Many of these headwinds are starting to wane, so he thinks Canada should see a little bit of outperformance relative to other markets going forward. The part of the market you want to be invested in, are businesses generating revenue outside of Canada, more dependent on US growth.

Why have Rate Reset Preferreds fallen off the cliff? When the Government of Canada cut rates, the 5 year followed and many of the rate resets reset to the government of Canada 5% plus reset spread. He was heavily invested in preferred shares in 2011 when he saw volatility in the market and it was a good area to hide. They are starting to look very interesting here. The problem with the reset spread now is that many of them are very, very skinny, so this is becoming a cheap cost of capital to CFO’s. Right now you have to assume they will not be recalled. Ask yourself what will be your yield post reset. From there determine if you are getting paid an interesting yield or not.

Canadian Telcos. Right now it is an extremely expensive market versus historic valuations. In the past, these multiples were not too difficult because you always knew there was growth in the pipeline. You had wireless, broadband, video over wireless. Doesn’t know what the next real growth catalyst will be. Right now, paying a premium valuation in an environment where rates might go up, there are better investments in the market.

Preferred shares? The reason we have seen these trade down significantly is that there is a lack of liquidity, a lack of buyer on the bid, and sometimes somebody will sell $10,000 of a preferred on the market and it gets pushed down $.50, and then down $1. That shouldn’t happen, so liquidity is an issue. He had exited these because at $25 you didn’t have any upside or downside risks, and now you are getting some upside potential with a good yield going forward. An interesting place to invest in.

REITs. There are some really interesting values along with some interesting volatility in the market. We are seeing some discounts that are very rare, almost historical, excesses. He is really watching Alberta where the fundamentals are still quite strong, especially in the apartment market. The apartment market correlates very well with the job market, and there is more talk now about layoffs in Calgary, so he has to assume that the apartment market will be affected, but doesn’t believe it will be to the extent that the stocks are showing. The REIT sector has been a little irrational. It is one of those fearful times when it is best to be greedy. He is fully invested. The economy in Canada is not that strong, so you can understand why retail would be suffering. However at the same time we are seeing a lot of demand for Canadian physical real estate. Many of the properties in the GTA have been trading at record low cap rates, very high values, despite the fact that office REITs of 52 week lows are not being touched. The US has a growing economy. Everyone is waiting for the rate cut information. He likes to take the position that whatever the Fed does shouldn’t affect your view on real estate. There has been quite a dramatic pullback in the US REITs lately, as people are expecting higher rates. That should be something you would Buy when that decision happens. They are well positioned to benefit from a stronger economy by raising the rates and they have lower debt, so they aren’t affected by the higher lending costs anyways.

Is a potential rising interest rate environment hitting the REIT sector too hard? Many of the REITs, very stable vehicles, are trading at significant, double-digit discounts. Because of that, this is a time you should be accumulating them. Buy something with a yield that you are comfortable with, and if it takes a little longer, that is okay. You have that income support.

Markets. He expects the returns to be lower and to be the new norm. We have slower growth and perhaps longer cycles. 5-7% is what he expects from the markets. Jobs numbers are rising and the wages that big companies pay are rising, e.g. MacDonald’s. We added a lot of good jobs to the economy. He thinks confidence may result in people spending some of the money they were saving. It is a head scratcher that we have not seen more growth after the 2008 stimulus globally. The US economy is doing fine. In Canada our debt has increased, but our assets have increased at a faster rate. Our debt is affordable because interest rates are so low. His strategy is high quality dividend stocks.

Split Shares. They are an unusual investment. They take a portion and say that is the ‘preferred’ part, and then the rest is the capital appreciation. They have no risk of capital. You get the change in the underlying equity magnified. They are not well covered by the street. You have to have a good advisor who knows how to use this in your portfolio.

Markets. We have been very quick to point to China as the catalyst for this whole event, and he questions that proposition. There are trillions of dollars wiped off of investors’ assets in the last 35-45 days. That was probably a little overdone, but in 2008, the 1^st drop started in May and started accelerating into the fall. Because of that he wasn’t going to take any chances this time. Still doesn’t know the answers as to what the real epicentre of this correction is. It definitely felt just a bit too organized. We are in a range right now, where he believes we are going to see some big rallies, which he wouldn’t get too excited about. We will also see some big downdrafts, which he wouldn’t get too despondent about. Has been going into this one with more cash than normal, 20%-40%. As an investor, if you have increased cash already, it would be a good idea to take a look at your positions that you are least comfortable with as well as those where you have made a ton of money on, and reduce those to more reasonable weights. Then wait for both what the Fed is going to do and the Canadian election. Mid to late October, has traditionally been a good time to deploy capital. That would be the time to be Buying, adding to names or establishing new positions. Don’t rush into the market right now.

Canadian Banks? 3^rd quarter results were good, but not spectacular. They didn’t show any cracks in housing and oil/gas loan books. It looks like underwriting revenue and capital markets is going to be down across the board. They are all yielding around 5% right now. Historically, it is probably a good entry point, but he would wait 6 weeks to see what happens in the Canadian elections, as well as rates with the Fed. If you don’t have any banks, you could dip your toe in now and do the balance in 6-7 weeks.

Markets. Canada has to go a lot lower. The US is fighting between 2 bookends. If the Fed does what it should do and not raise rates, then everything is fine and look for about a 12% bounce in the S&P 500. If all does not go well, 3^rd quarter earnings as well as the Fed, look for about $1750 on the S&P 500, about 10% down. If it goes down there, there would be a huge tradable rally at that level. Raising rates is more of a political decision rather than an economic one. China is looking at corporate tax cuts, and these are drips of desperate actions. They have a “balance of payments” issue. In the month of August, they spent over $100 billion in keeping the Renminbi at a level at around the US dollar. They are spending $4 trillion of Foreign Exchange reserves, and that is going to continue until there is meaningful devaluation in the Renminbi. When China does devalue, it will be quite large. Unfortunately that is going to set up a deflationary wave globally. We have to get ready for very volatile down markets, but in the interim, we seem to have these huge relief rallies. He favours US assets. Every day the US$ looks bigger and bigger. Any US assets are good, but if push comes to shove, the S&P will come down to about $1750, but he thinks it becomes stable there.

Which Canadian bank or insurance company to hold for 5 years? They all have to go lower. Thinks the Bank of Canada reduces rates significantly in the future. Interest margins are getting squeezed. A lot of people have all kinds of concerns, certainly on real estate and its value. He is underweight both of these areas.

Markets. There was no change in Canada to the overnight lending rate. This is encouraging. There was two months of trade data and we saw the benefits of the Dollar in exports and the employment data has been slowly improving also. It is encouraging and we should see the back half recovery. There were fears we were in a technical recession when we saw China had slowed. For Canada now, if the US goes back into recession, it will be a huge negative for Canada. We are seeing that the US economy can decouple from China. It can grow is China continues to weaken. She is just focusing on the economic fundamentals. If the Fed raises interest rates 25 basis points it will not stop the economy growing.