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

Interest Rates. As anyone who has held a portfolio of REITs has found out, the moment there was a suggestion of the US beginning tapering, the market collapsed on the REITs. This was very much overdone and there has now been a reasonable recovery. Feels REITs are now reasonably priced. Doesn’t think the concerns about REITs suddenly roaring up was ever justified, and the market is beginning to realize that. There will be a gradual increase in interest rates over time, but with inflation so low, he doesn’t think this is something that will happen very fast.

Forestry sector? He is pretty light in this sector, but at the same time with the Cdn$ being down, it is a real benefit. They are selling into international markets. The forestry industry may benefit as well from increasing Chinese demand.

Markets. Central banks globally are remaining very accommodative and putting a floor under the market to protect. Expect rates are going to stay low for the foreseeable future. World economy is very fragile. Europe is barely coming out of recession, fighting deflationary forces and still has huge amounts of sovereign debt to deal with and the banks are not in great shape. Also, have high unemployment and aging demographics. Japan is desperately trying to reflate its economy and the value of the yen, which may lead to another Asian currency crisis at some point. China is really slowing down. Trying to stave off its own debt crisis, because their banks have overlent to corporations and local governments have overspent on infrastructure. US is plodding along with not great growth, but growth. Low rates are here to stay and that is going to keep a floor under the market, but things are getting very expensive. For his clients, he has been increasingly conservative over the last few years. Has about 10% in cash and still has about 35% of his portfolios in high-yielding dividend stocks such as power companies, pipelines, telecoms, renewable energy, etc. Even though they are getting a bit expensive, he still feels dividend yield is very important, and give some stability to portfolios.

Markets. We are in a very low interest-rate environment and there is a lot of money in the system and that money is creeping its way into the system. Looking at the S&P 500, revenue growth has been very, very low for the last couple of years, so businesses have done a great job of squeezing profits out of very, very flat sales growth. It continues to be a challenging world to be an investor. While everybody is looking for stronger economic growth, there will be a point in time where interest rates start to rise, probably above nominal GDP growth of about 3.5% or so. That will start posing a problem for stocks at some point from a competitive threat and also these falling rates have been a real win at the back of corporate profitability because they’re borrowing costs have been falling. There is a potential for rising rates, US$ has been strong lately, which could start crimping international sales profitability of the S&P 500, where about 6% of sales come from. The stronger US economic growth could start becoming a bit of a problem for stock valuations.

What impact will the declining value of the Cdn$ have on the investment banking portion of the big banks in Canada? If you want to look at direct exposure to the American$ through operations in the US, the 2 biggest banks would be Toronto Dominion (TD-T) and Royal (RY-T). RBC Banking have done a fantastic job of building up their capital markets exposure in the US and are one of the top 10 players there now and continue to execute exceptionally well. You also have to look at Bank of Nova Scotia (BNS-T) because of the Latin American currencies. A strong US$ and a weak commodity environment is going to be pretty bearish for those currencies as well.

Markets. Does not think the Canadian gov’t will cut rates because it would further inflate the housing market. $0.89 is a good support point on the Canadian dollar. We are experiencing some disinflation in Canada but the lower dollar is boosting prices of imported products. This is not ‘good’ inflation with ‘good’ inflation being increased job salaries, for example. Mining has been crushed and will not come back immediately. It is setting up for a nice trading rally. Gold is not going to do much here. Thinks gold will go below $1200 sometime in the summer.

Japan has been doing QE for 17 years and it has not been working. No organic growth and they don’t want foreigners coming into the country. We are in a weaker yen cycle. EJW is a good way to play it. DXJ has a currency hedge. He doesn’t love Japan right now. It has had a good run but has not got a lot of upside.

TFSA’s: If you are going to speculate, you should do it in the TFSA. If you are successful you will never get taxed. A cash account gets taxed right away. If you think of the TFSA as a bank account and are in and out then don’t speculate. ZRE-T is a good way to play it. Thinks REITs will start to get attractive.

Educational Segment. Fight or Flight response. Significant losses in the portfolio cause this response. We see it in functional MRI research bit also in mutual fund money flows. E.g. 2008 crisis, Leman crisis. When returns are generally good money flows in and when returns are bad money flows out, which means people are chasing past performance.

Markets. Some people question if we are in a secular bull or bear market. He has no doubt we are early in the secular bull market but early in the cyclical bull market. Energy markets are coming alive. Some stocks might be subject to a correction but longer term it is a bull market.

Markets. There might be a 5%-10% correction in the US, but given where interest rates are and where global growth is happening, he doesn’t see us having a major correction. Some things are fairly valued and some are highly valued. There are some sectors that did really well because of high dividend yields, etc. But overall, he expects to see reasonable growth in the US of about 3% and expects it will be a very good year there. Globally we could have a better year. Corporations are in good shape. People are saying margins have peaked and is going to be an issue, but they are forgetting that if you have top line revenue growth, margins can expand. The cost structure of a lot of these companies are way better than they were 5 years ago.

Markets. Optimistic about 2014. Seeing the positive signs in the US economy and the European economy as being a lot less of a drag. Biggest challenge we have is in Canada, but hopefully the US strength will pull us out of it. Expects there will be a bit of a lag in Canada. Weakening of the Cdn$ should ultimately be good for a lot of Canadian businesses. Likes lumber for the homebuilding in the US. On the retail side, cost of goods is obviously going to go up as a lot of them are priced off the US$’s. Something like lumber or manufacturing sector, where they are selling goods in US$’s with a lot of their input costs in Cdn$’s is definitely a win. Airlines had a big run and the drop in the Cdn$ is definitely going to hurt them on the cost side. Fuel makes up about one third of their operating expenses so that is definitely a headwind for them. They’ve had great runs, so he would probably avoid this area.

REITs. Fear of higher rates was overdone. REITs had a very good run for long period of time and there were a number of equity issuances and new REITs that came out at that time. When Bernanke made his tapering comments that was the tipping point. Bad news has now been priced in so it is now offering a good opportunity to get back in. Long-term investors in real estate should be looking at REITs as a form of cash flow. Return on real estate mainly comes from income, so you want to look at its yield. Sometimes you have to go beyond just the dividend yield because a good REIT will not pay all of that out but will keep some of it. You have to look at if the cash flow stable. With the amount they hold back, they are able to regenerate returns, right in the middle of the portfolio with real estate they already own, finding better uses for it.

Significance of a distribution of a REIT being designated as Return of Capital, particularly when the percentage is a very high percentage of the distribution? In the dividend that you receive, it is actually composed of different kinds of capital. If you have a return of capital, that actually lowers your base so your book cost goes down that amount. If you are holding this in a taxable account, you don’t pay tax on the income. Theoretically, you should hold these in taxable accounts, not in an RRSP.

Markets. He is seeing an alignment of opinion on Wall Street. Fixed income vs. equities. It is unanimous that equities will outperform bonds in 2014. Tapering economic stimulus is not tightening. Fed has said they will act prudently to what happens in the capital markets. He believes there will be a reacceleration of economic activity in the US. Growth will be 3%. Believes it is compelling to continue to lighten up on bonds and move into equities. It is just a question of how much money you want to risk losing in bonds over the next few years.