John O'Connell, CFAA Comment -- General Comments From an ExpertA CommentaryN/AJul 13, 2015

Nothing has been sleepy about this summer, or this year in general. Feels as though we're on a constant seesaw. War on/off? Interest rates down/up? Economy weakening/strengthening? If US jobs numbers are weakening that might be a good thing, as perhaps interest rates won't go up. 

And now we're also in the middle of earnings season, so we're seeing a lot of volatility because of that.

Mostly positive. Her focus isn't really in the AI-tech space, so she can't comment on some of the negative earnings today. When you're trading at really high valuations, you're priced to perfection. Even a small revision to estimates, or a small miss, results in a large stock price move. Energy stocks have been pretty good with oil prices higher. 

In general, pretty volatile. Yesterday, all the pipelines that she loves and cherishes were down. Why? Was it because SHOP was up 20%? Because oil prices were up? So hard to tell in this type of market what's causing the moves.

The best thing for her sanity and client portfolios is to look through the short-term noise and focus on the long term.

Preservation of capital is the most important thing for her clients. This actually makes it very difficult to invest in this type of environment, since market valuations are elevated. Even the boring stuff that her firm owns might be trading at 20-year highs.

The other thing to focus on is dividend income. If you're collecting 4-5% in the form of dividends, then regardless if the market is up, down or sideways, you're still getting income year in and year out. Stock price only matters when you're looking to sell. Her firm wants to own names for 5, 10, 20 years. Look through short-term volatility, and use weakness as a buying opportunity.

For new clients, they're sitting on too much cash really. With valuations elevated, it's hard to find decent places to invest. For example, it's been hard to buy Canadian banks this year.

For clients already invested, dividends that aren't withdrawn have been put into money market funds. This provides dry powder to deploy if there's a correction.

With the SHEL takeover of ARX, international players are starting to look at Canada. We have a low-risk jurisdiction and access to Asia. Because SHEL has a stake in LNG Canada, we're going to see expansion there.

Right now, we have too much production and not enough places to put it. But we're working on it.

She's stronger on gas than oil at the moment because of power demand. We're going to need baseload energy (data centres and reindustrialization back to NA), and though renewables will have a role, the rest will have to come from natural gas or nuclear. 

Hard to look at any of the banks trading at 20-year-high valuations when we have a weakening economy. Something has to give, and she thinks it'll come off the bank stocks. Capital markets and wealth management have been the real drivers. People look at banks as bellwethers for the economy; if the banks are doing well, the economy must be doing well. She doesn't feel that way.

At the end of the day, they'll do well because of their oligopoly position. Underlying businesses are OK. She's just not comfortable buying at these valuations. If we get a correction to our economy, the banks will be the first ones hit.

Yes. A lot of people are focused on the Iran war right now, which is clearly having a big impact on the price of oil up and down 5% based on Trump's tweets.

But if you look at the longer-term picture, there are a couple of things. First, global underinvestment for the last 10-15 years in the sector, particularly E&D. So the reserve life of most of the global players is much lower than long-term averages. Increased E&D bodes well for spot demand balance going forward.

Secondly, the oil patch in Western Canada has really found religion in fiscal discipline. Companies are spending within their capex budgets. Also new-found enthusiasm for returning capital to shareholders -- paying down debt, share buybacks, or healthy dividends.

Because Canada can boast longer reserve life assets, our companies are very attractive. Most of the Canadian industry trades at a significant discount to global peers. Canada has not only better assets, but they're cheaper. Eventually people will realize that, and we should see more $$ flowing into Canada.

It'll be at least 12-18 months before we see things coming back to normal. We lost close to 1B barrels of production. A lot of places like the Philippines, which had to ration, are thinking about instituting a strategic reserve. Even Doug Ford was talking about it for Ontario. Damage to facilities will take some time to come back online as well.

He thinks the market's gotten ahead of itself with WTI down to $75 again today. He's looking at $80 for the second half of this year and the rest of 2027.

About 2 years ago (and updated recently), his firm analyzed who was/was't investing in Canadian oil and gas. It was very clear that pension funds were not investing. His own view is that the Canadian pension fund model chooses "exciting" investments to visit around the world rather than solid investments "just down the street". Politics also comes into it.

The oil & gas sector is the most productive one in our country. When we talk about the productivity issues that Canada has, putting $$ into our most productive sector is how to stimulate our economy.

His team also looked at the 10 most actively managed funds in Canada. Two years ago, those funds had 6% energy exposure, now up to 10%. Getting better, but still massively underweight compared to the index weighting of 18%.

Because of the size of the pension funds compared to the rest of the market, they can really only invest in the top 5 or 6 names. There's a big gap in investing in companies whose market cap is less than $10B.

The banks aren't big players in the oil patch either. Average size of a Big 6 bank energy fund is $139M, average exposure to Canadian energy is only 27%. The bulk of them are invested in gold super majors and the big 6 Canadian energy names. 

No one's looking at the tier below the $10B mark, and that's what his new ETF (COIL) is trying to take advantage of.

Usually you see a blip in August, post-earnings until the traders come back from holidays to break the quiet, or the euphoria over the next earnings. Something somewhere pops out to make the markets dive 3-5%. He expects this bull run to continue. Earnings on strong and the economy is strong. Canada is exiting a technical recession and the CUSMA deal is unsigned. Unemployment is steady and job growth is okay and the consumer is spending, especially the rich. Unfortunately, war is good for the part of the economy producing the equipment.

Yes, the PEs are very high and the dividends are very low historically. Any blip in the economy or credit could mean earnings will take a beating. There's little margin of safety on the earnings. Take profits on the banks if you're collecting a huge profit. He doesn't own the Canadian banks now. How much can earnings growth in this Canadian economy?

There was a lot of geopolitical risk that everyone was watching closely. Investors were digesting higher valuations and potentially shifting interest rate expectations. This week, markets have regained their footing.

Markets are looking past recent volatility and turning attention back to corporate earnings, where we've had some strong results over the last few days. The latest results are reinforcing the fact that businesses are continuing to invest heavily in AI. Investors are becoming more selective on which companies they want to own, the AI investment cycle remains intact. It's still creating opportunities across multiple sectors.

The economy has given investors plenty to think about. Growth is slowing a bit more than expected in Q2, especially in the US. Inflation has eased slightly since a month ago and the labour market remains resilient. Instead of a recession, her team believes the data points to settling into a slower, but more sustainable, pace. This is encouraging for allocating capital. Interest rates are likely to remain elevated and hikes are back on the Fed's table until inflation is under control.