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

REITs. Some of the popular REITs have run, but there are still some hidden treasures that can be found. In the REIT market you are really looking at the relative valuation, and understanding what the value of the properties are. The real run that has happened now has really been focused on those largest real estate investment trusts, and a lot of the smaller and mid-caps have been left behind. He has had a preference to the US, however they are up 16% to date, so you have to be a little more cautious now.

Markets. Investors have got to stop trying to call a Top. Experts say “We are due for a crash” again and again. Investors should just get invested and stay invested. Since 1970 we have had 4 crashes. ’73-’74, 1987, 2000 and then the financial crisis. In each case, every time we’ve had a nasty so-called crash, the markets still ended up higher. If we have a 10 year time horizon, stop worrying if we are going to have a crash. We’ll have corrections, 3%, 4%, 5%, but that’s meaningless. Buy good stocks and use Market Rotation. In our own markets, financials and telecoms lead and then you have the middle of the market where you have consumer, technology and then at the tail end of the market you have the materials, mines and metals. That is a normal rotation. We are running into a sort of Global Rotation now. The early part of the bull, following the crash, was led by North American markets. They are now starting to lose momentum and the cash is going into the back end of the market, emerging markets, South America, etc.

Markets. It is like the ‘90s. It didn’t end so well. There was a great time when investors were able to make lots of money because of the Fed, and growth wasn’t too hot, or too cold. It is like that now. Where are people with cash going to go? Dividend stocks with rising cash flows and 3-5% dividends. We are in the half disbelief phase. Own quality and practice asset allocation. No one knows when things will change. If you have some kind of Leman event, you have to have a switch you click off to protect yourself and that is with futures. Energy trade looks attractive but it is stock specific. If a stock is not accurately discounting future cash flows, it is a buy.

Markets. There are periods where there is a lot of change and transitions, and then you go through periods where there is some fairly steady leadership. For about a year now we have had very steady improvement and breadth in the market, meaning more and more stocks are slowly participating. He sees a very healthy environment. Alternatives would be a 2.5% treasury bond or an average stock in the S&P with an earnings yield of somewhere north of 7%. This means you get paid very well to take equity risks today. Unless you think rates are about to shoot higher, equities are probably the place to be focused, and there are some very clear themes in the market.

Energy. His exposure has been going up through the year. For about 4 years now he has been focused on energy infrastructure, but in the last 6 months he has really extended his exposure to producers and service companies. It is not so much a story of the price of oil, but just a boom in volumes and falling costs in finding and lifting new reserves. The cost to find and lift new reserves has fallen about 12% a year for the last 4 years. They are mass manufacturing energy in the US right now, and a lot of companies are benefiting. His equity portfolios are above 40% in energy across a broad spectrum of different themes. Natural gas companies are doing a lot better for the first time in a long time so that is a newer theme for him. The net of this is that the cash flow generation is growing, and the costs to bring on new reserves have come down to such a level that this is just a good margin business.

Markets. Market has been very good this year. One of the better G 20 countries, much better than the US in a lot of places. For us to push through our all-time high, we do need energy companies to go a bit higher with growth in production and cash flow, and thinks we have a decent shot at it here. He has been fully invested, but started taking a little bit of profit the last couple of weeks. Thinks a correction becomes a “time correction”. Everyone is saying, ad nauseum, that we are due for a correction, and therefore it probably doesn’t happen in exactly that way. You might get a series of rolling 3%-5% corrections, and then come back, and we end up net flat from here to September. Valuations are now fairly valued, but we now need earnings to follow through. More than ever, to him, it feels like a “stock by stock” value. You can’t just throw a dart any more because some things are more fully valued than others.

Global Growth. World Bank cut its global growth forecast, from 3.2% down to 2.8%, and he sees some weakness in US, Russia and China. He is still looking for something in the mid-3% range, and thinks economic growth will pick up materially in the back half of the year. US had a tough economic 1^st quarter because of lousy weather hitting all kinds of industries. To the extent that the US is roughly a quarter of global GDP, it is not surprising that as the US suffers over finite period that it will drag down the whole data set. This is still going to be better than 2013, which was better than 2012, so the direction is going the right way. The key economies of the world are picking up steam. The EU will demonstrate positive economic growth for the 1^st time in 3 years. US growth continues to accelerate, although far below what you would normally expect at this point in the economic recovery. Japan will grow for the 3^rd year in a row at a reasonably static rate, but the good news is that inflation has cut back, which augurs well for long-term spending. The only economy that seems to be having problems finding a bottom and recovering is China, whose growth continues to decelerate, albeit from fantastically high levels.

Valuations. Geographically, he would say the US is more fair value. Valuations are certainly a little more attractive in Europe and probably more attractive in Japan as well, given that the fundamentals are improving so rapidly from a profitability standpoint. Another area is Asia ex-Japan, the Chinese peripheral markets, such as Singapore and Hong Kong, which are trading much below their historic norms. This reflects concerns about the Chinese economy.

An ETF in the BRIC category? Growth has pretty much unwound in all of these countries, particularly in Brazil. Russia is a market that he simply would not invest in. India is really the star of the show, because with the election that recently happened, stocks that had been languishing for a good 4-5 years have had a spectacular run year to date. The appetite on China is absolutely abysmal, but it is the cheapest market in the world at about 9X forward earnings. On a country basis, it would be China and India he would steer you to. However, he would not advocate an ETF for these markets. You are much better off using individual stocks.

Canadian Banks. Moodies has downgraded Canadian banks, but there is really only one banking system that even comes close to the Canadian banking system in terms of strength, and that would be Singapore. Canadian banks are fantastically strong, and the regulator is very competent. He doesn’t think the valuations are particularly demanding right now. (See Top Picks.)

Bond Markets. Heading into this year, there was a pretty nice selloff. We saw US 10’s get up to 3%, and it was almost one of those year-end capitulation type trades. 2013 was obviously a bad year, and had negative returns. It’s very unlikely to have a repeat, so he was less negative. However, we have had a pretty nice rally, and are up almost 5% on the year in Canada already. Thinks the market got overdone. Everyone was calling for higher rates to happen for the last 5 years, so he has always stayed positioned to stay Short on ordinary credit. We had some bad weather and economic data has not been as strong as most were hoping for, whether it was overseas, China or Europe. US numbers have not been great, and there was a contraction in the 1^st quarter. We are now at the point where we may slowly creep back up. The record lows right now are in Europe. German 10 year yields are at 1.3%, whereas the US hit that level back in mid-2012. He is probably back to where he was this time last year, where within your overall asset allocation you want fixed income to be at a minimum. For example, someone who is usually 60% equities and 40% bonds, they are probably down to 30% in bonds with the balance going to equities or elsewhere.

Real Return Bonds for 2026? To go that far out is very dangerous right now. A Real Return Bond pays you a guaranteed rate of return in past dollars. A 2021 bond would have been issued in 1991, and it will pay you in 1991 dollars, which is worth about $2 today. The problem with Real Return Bonds is that rates have been depressed by the Federal Reserves quantitative easing program, and Canada has followed suit. As rates are expected to rise over the next several years, it is not about rising inflation expectations, but about rising real yields, which means these are really going to get hurt. Either stay Short and look to getting some credit, or floating rate notes will give you the same sort of inflation protection that a Real Return Bonds does.

Earning 2% on bonds versus 7% on a stock? It’s all about the guarantee. With a Canada government bond yielding 2%, you are guaranteed to get that 2%. On the stock, 7% is not just on the dividend stream but what are you going to be able to sell the stock for when you need the money. There is a lot more risk and volatility on stocks. There is always a place for both stocks and bonds.

With the potential onset of inflation and higher interest rates, what could the impact be on high risk, high-yield corporate bonds, and is there a tipping point where the risk is going to be far greater and not worth it? We are getting close to that tipping point. The real story with the higher yield and high risk bonds is the yield pickup over government bonds. Historically that has been as low as 3% extra to as high as 12% extra. Right now we are at around 4%-4.5% extra. Relatively expensive. When that does start to turn, this asset class will sell off just as hard as equities will. Be very selective of the bonds you are buying or hire a good manager that can do that for you.

How would you structure a bond ladder with $100,000 in a registered account, including types and maturities of the bonds? On an RRSP ladder you are going out every year to 10 years minimum, because the RRSP is a long-term strategy. He would exclusively go into strip coupons with a 50-50 mix between provincials and corporates for the extra yield.