Jon VialouxA Comment -- General Comments From an ExpertA CommentaryN/ANov 25, 2016

In spite of a lot of geopolitical headwinds for the last 4 months or so, optimism has been pervasive. We got a fresh burst of it in August with both the S&P 500 and the TSX surging to record highs. Both those indices are up over 7% since he was last on the show 2 months ago. 

This is all concurrent with the release of Q2 earnings, and they're phenomenal. In Canada, earnings are up 15% compared to the same period last year. More than 30% in the US.

The enthusiasm is well validated by fundamentals.

There is that. They also say that the first casualty of war is the truth, and that's certainly been the case from both sides in this conflict. Yes, it appears that investors are shrugging off the war, perhaps hopeful that it will end.

As it relates directly to the economy and corporate earnings, markets do seem to be shrugging off high oil prices (down from peaks, but elevated from a year ago). Higher oil means higher inflation, which has implications for monetary policy. Markets are settling into an expectation that rates will, at best, stay steady through the remainder of the year.

There's a tug-of-war being set up between interest rates and inflation. The score is on the tape; earnings are winning.

Interestingly, the Magnificent 7 are no longer so magnificent. The group is up ~2% from 2 months ago, which trails the S&P 500 (which itself trails the equally weighted S&P 500). Seeing a broadening out of investor interest.

After 4 years of this capital spending arms race, we're starting to see trickle-down benefits flowing broadly into the mainstream economy. The most rabid enthusiasm is still in semiconductors, hyperscalers and memory, but we're starting to see some of the benefits of AI usage trickle down to garden-variety businesses.

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.