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

Educational Segment. Two weeks ago he launched a Sleep at Night Portfolio. The covered call ETF (ZWB) on the banks did very well but banks are overbought so we could trade it out at this point. Overall, he had a yield of 0.06% and beta of 0.48. So he replaces the banks with preferred stocks. He added PFF-N and GLD-N. By reducing financials and increasing preferreds he reduced beta. Results over last two weeks:

Markets. Non-Financial and Non-Resource N.A. equities are today’s topic. We had a very large run in the US since 2009. A lot has been a lack of alternatives. The Fed squeezed you out of bonds, so money flowed back to equities. After 2008's experience, people may move back to bonds for only 3%. He thinks the money flows into equities are gone and now companies are on their own. He always does bottom up. He is worried that the economy may not be as strong as people think based on fast earnings in big blue chips.

Canadian Dollar. In the short term the Canadian Dollar will not do as well against the US with oil at $110, but he is bearish on oil long term. It won’t go back to par, however.

Mutual Funds. Every year, Standard & Poor’s put out a report that compares actively managed mutual funds against their benchmarks to see how they’ve done over different time frames. Results for year-end of 2012 showed that in the Canadian category 41% beat their benchmark, over 3 years the number is 15.39%, and over 5 years it is 9.84%. In the US, over one year, only 12.31% beat their benchmark, over 3 years, it is 4.22%, and over 5 years, 4.55%. Internationally one year is 14.71%, 3 years is 5% and over 5 years is “no one”. So odds for beating a benchmark for an active manager are low to begin with and then diminish over time. You should be looking for investments that are broadly diversified, cost-effective and tax effective. Either an asset class fund or an index fund, but not an actively managed one. Other than that you could use Exchange Traded Funds (ETF).

On a TFSA, if a person has deposited $25,000 and now has a profit of $5000 and they take out $5000 how much could be contributed next year? Whatever you take out, whether it’s $5000 or $30,000, you have to wait until the following year before you can put that money back, but the following year, January 2014, you’ll get an additional $5500 of room. That is, you can put back what you took out plus $5500 in 2014.

Interest rates. Rates have nowhere to go but up. Has moved almost 85%-90% of his interest rate sensitive products out of bonds, bond funds and bond ETFs and into equity linked GICs. He thinks this summer, around June, we hit the absolute point where rates are not going back up and the 30 year bull market in interest rate sensitive products is over. We are now at a point where short-term rates haven’t moved yet, longer rates are already up and mortgage rates are coming up and have been for the past few months. That is likely to continue for the next 3 years, and maybe 5 years.

Caller has RRSPs and some grandchildren’s RESP’s held in bank held mutual funds with 2%-2.5% MER’s. Is there a mechanism that he can transfer mutual funds to low MER ETFs in a brokerage account? 1^st of all, whenever you transfer one product line fund to another product line in an RRSP or TFSA there are no tax implications whatsoever. However, the funds should not be withdrawn as that will trigger taxable implications, so this should be a straightforward transfer, not a withdrawal.

When mutual funds pay out distributions and highlight them as “return of capital”, what are the tax ramifications? A “return of capital” is tax-free. They are just giving you your own money back.

Markets. Fairly valued and certainly not cheap. We are 3 quarters into a full cycle here. Markets are pretty optimistic. Analysts’ forecasts have been consistently rising. Forward PE multiple is about 15 times for the S&P 500, which is about a historical average. A lot of appreciation in the market in the last year has actually been PE multiple expansion, not earnings expansion. Looking at earnings in the last quarter, on a year-over-year basis and taking out financials, earnings were actually down for the quarter. He exited a lot of his investments earlier and is doing a little bit of trimming. Finding it very hard to replace the investments that he sells. When he looks at likely valuation of companies he would like to own and put an average PE multiple on them, he is getting sub par returns. His equity fund is holding 45% cash.

How important is the retail investor to the market? His sense is that the retail investor has become less and less of a meaningful player in markets in general. Feels they are fed up and haven’t been served very well by the financial industry. Now they have choices of thousands and thousands of ETFs and don’t know which one to buy. Thinks the high-frequency traders are masking how much volume actually really ever existed. It’s a major problem that the capital market and stock exchanges should address but exchanges have become big businesses and their primary motivation is to have trading and trading volume and they don’t really care about investors.

Markets. The big thing for him is the interest-rate picture. A lot of people were surprised when the Fed basically said that higher rates were coming. That is a major shift for a lot of investors, especially if you are invested in things like dividend stocks. REITs in particular are at risk. But by and large, things are looking good. US economy seems to be ticking along okay. Not perfect, but you get more good news than bad news. Also, Europe, seems to be coming back a little bit. If you are confident, you want to look for companies that are economically sensitive and maybe have a little bit of debt, because that debt will give you a turbo charge return if you are right. With REITs, you have to be a little bit careful because they are not all the same. They have been so popular for the last several years and are priced for perfection. Some REITs did well simply by refinancing, which can mask a lot of ugliness. You have to figure out who’s a good manager and who is creating per unit earnings growth before interest payments are calculated into it.

Markets. Fears in the US housing market are largely overblown. Some weaker data is just a pause in the context of a longer term recovery. Interest rates for US mortgages went up slightly but they are really still very low and over the next few years you will see more and more housing starts. You can play by Home Depot of Bed, Bath and Beyond for conservative investments, or a more pure lumber play. Neutral on Canadian Banking sector. Favours US financials because of more upside. Canadian housing crash is over blown and banks are not going to crash. Should be a flat environment. He has been looking more closely at Energy recently.

Gold. A lot of volatility in gold recently. He doesn’t worry too much about short term day-to-day volatility. Over the long term he wants to have a holding and is now low at 3%. ETFs weight toward the large caps and that is the way to go. Trying to bet on one particular company is very difficult.

Markets. September, seasonally, is by far the worst time of the year. 60% of September months are negative and you are looking at an average return of negative .05 over the last 7 years and .07 over the last 20. In addition, there are tensions in the Middle East so there are bumps ahead. He has about 20% in cash at this time and is dipping into certain areas that look interesting. Favouring the US over Canada right now. Canadian index is filled with either interest rate sensitive stocks or resources. On resources, China is moving away from the infrastructure story to the consumption story.

What is the best way to play the housing recovery? Housing stocks or lumber stocks? Names like Louisiana Pacific (LPX-N) will be much, much higher beta than a Home Depot (HD-N). Between those 2 you are looking at homebuilders and those types of names. Another way to play it is to look at some ETFs such as iShares US Home Construction (ITB-N) or SPDR Homebuilders (XHB-N). The lumber stocks are going to be a lot more volatile.