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

How do you calculate free cash flow? Simply, CFO (cash flow from operations) minus cash dividends paid minus capital expenditures. If it grows over time, you have an unusual company that merits a closer look.

His outlook hasn't changed since he was last on the show recently. Volatility will continue for the next little while. There will be violent shifts. The technical quality of the recent rebound was suspect. We've seen our peak in economic and profit growth. Profit margins are peaking as material costs and wages rise. We've had a great 9 years, but it can't continue forever. Headwinds, like rising interest rates, are emerging. 2018 reminds him of 1987. He's staying defensive. There will be buying opportunities, but investors will be wary. He's staying on the sidelines with a lot of cash. If he buys stuff, he'll move in and out of it quickly, even tech. For example, he sold some Facebook recently based on valuation, not the headlines.

Are we 6 months from a world collapse? It's possible, but unlikely. Financial crises always arise from a debt crisis. There's high consumer debt in Canada and corporate debt in China, for example. He doesn't think a collapse will happen. However, he feels we're closer to a recession than anyone thinks. Stocks peak 6-9 months before a recession. He's read some worrying financial reports from the U.S. and abroad. He sees warning signs, particuarly debt, and he's staying cautious.

Floating rates preferred shares as a fixed income strategy during rising interest rates? He's overweight, at 15%, preferreds in his portfolios. The problem with them is they're not equity or debt, so in a down market they get the worst of both worlds. There's a sustainability issue, so they will act worse than bonds. They're attractive now--and he's been managing them recently--because the gross yield is so high.

What to do during high U.S. volatility? He's hanging onto what he has. He isn't adding to holdings and reducing a bit. Maybe he's chicken. US tax cuts may help the economy. Rising interest rates, yes, but they're not long-term rises which truly matter. He's cautious about the American economy beyond 2018. There are warning flags, like a possible trade war.

Market. He focuses on small and midcap companies that are likely to rise based on their own fundamentals. He often invests heavily in a company, and several of the companies he invests in are bought out because small healthy companies are good targets for buyouts. He’s sitting on a lot of cash. The markets have been very expensive, especially since Trump became president. There is risk in trade wars and from multiples that are too high given rising interest rates. The US economy is growing, 2-3% growth, while good, is not good enough to keep up with the multiples. He found good value in small caps and mid caps, but the companies were taken over after he bought them. The heavy investment in ETFs focused on large caps is creating opportunity in the neglected small/mid cap space. He is particularly interested in Canadian companies expanding in the United States. Several of these are primarily American companies that have a Canadian head office or Canadian companies with strong American subsidiaries. They offer a lot of growth opportunities within the US. His investment approach is to look at growth opportunities of individual companies rather than focusing on the macro.

Compared to the last few years, the recent market swings are shocking, but we are actually getting back to
normal, with this increased volatility in early 2018. The bark is often louder than the bite when it
comes to politics (i.e.Washington). For long-term traders, pick your spots and stand by your
convictions. Day to day, this will be a rough ride--It's unproductive to watch the markets so closely
every day like this. The key thing is to be comfortable with what you own, prepared to
absorb say a 6% drop, and keep looking long-term.

Market. He thinks the recent volatility is the new normal. The VIX averaged less than 10% implied volatility last year, while this year we are averaging over 15%. Trade tariffs are not good for the market and maybe the recent Trump Administration warnings about China are simply a way to bring them to the negotiation table. These concerns are clearly adding volatility to the market. He does not think we will see a quick resolution as trade deals take years to complete. NAFTA will likely hinge on a May 1 deadline with the upcoming Mexican elections. The leader in the polls there is very anti-American.

Why diversify when correlations are increasing? An excellent question, he says. As information flow has improved over the past 50 years, correlation among markets has increased. Over a 10 year period, correlations among regions and sectors have approached 1. You still have to look at valuation and you want to put money in areas that are relatively better value, not the expensive ones.

Educational Segment. Should market similarities with 1987 have us worried? Last week he saw a lot of technical comparisons being made to 1987, prior to the crash. The recent corrections do look like the pre-crash period. There were similar trade tensions and trends toward Central Bank tightening. Despite this, he is predicting a pending crash. Wrong policy decisions on trade by the Trump Administration could cause problems, however. The crash in October 1987 caused a 40% retracement back to where the market started the year. It took about three years for the market to recover back to the previous high – an annual return of about 14%. There was a lot or market noise in between, but good returns in between. He is concerned about the next recession, where he thinks there could be a market drop of 35-40%, when earnings fall and market multiples fall to below normal. He is getting concerned about 2019, when he sees many fundamentals pointing to headwinds and greater risk of the next major recession.

Preferred Shares versus Bonds. By and large the newest preferreds are rate-reset shares, compared to perpetual preferreds where the dividend is fixed. With rate-reset shares, an increase in interest rates will see dividend yield increases, which gives better protection than bonds and perpetual preferreds. He likes the Horizon Actively Managed Preferred ETF (HPR-T) over buying individual preferred stocks. He does not mind paying a higher MER in this class of ETF for the management. He thinks a general rule for preferreds could be to hold 10-20% in your portfolio.

High Dividend Stocks. Just because a company has a high dividend does not make it a good company, he says. He prefers to buy a diversified basket of dividend payers in an ETF, especially if it uses covered calls.

General Market Comment. He thinks we are still in a secular bear market that began in 2000. From a cyclical perspective it has been a bull market since 2009, set off by central bank spending, he says, which has meant the global debt bubble has not been allowed to deflate. Now, we are seeing volatility returning to the markets over the past six weeks and this likely here to stay.

Market sensitivity to interest rates. Market sensitivity to interest rates is much greater than in previous cycles, since we have not had a recession to cleanse the bubble growth like in the past. Flattening of the US yield curve, combined with protectionist trade actions is leading to another inflationary or stagflationary impact which could stall long term growth and could become toxic to the market. If we see a break below 200 day moving averages for a period of time, it may unleash some pent up selling pressure.

Commodities relative to equities. Relative to equities, the commodity sector is the cheapest it has been since the 1970s, which was a great time to be buying commodities. He thinks this could be similar. Interest rates and inflation expectations are starting to bubble, leading him to favour commodities.