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

Criteria for dividend growth stocks? The first thing he cares about is a strong business model. You want one that is durable, gives good visibility, and good re-investment potential. When a company generates strong cash flow, you want them to be able to deploy those cash flows with good returns. A cash flow metric is very important, because that is what dictates the capital return policy. Free cash flow divided by the stock price is a key metric for him.

Markets. There are some dividend names he is a little cautious on. There is a bit of complacency out there, particularly in a number of some of the expensive defensives. He builds a portfolio on a bottoms up basis, making sure that everything he owns he truly likes. He would rather own management teams that can be opportunistic and do things when it makes sense. A lot of valuations are not low, and now is not the time for companies to be buying back aggressive amounts of stock in many cases. A very important point; DRIP programs at the end of the day are simply issuing more shares. It is very important to not just look at yield, but look for companies that are giving a better total yield, not just a high dividend yield.

Market. The Bank of Canada governor indicated they are not changing interest rates, still staying at .5%. He also made comments about the economy. It is a slow growth environment, but getting better. What wasn’t said was that Canada wants to see what the federal reserve does, and react to that. Although we may look to the central bankers globally, history tells us that they are as wrong as any of us. It is a very, very difficult thing to get ahead of the curve. Central bankers, for the most of the time, tend to be reactive. This is a very, very slow growth environment, which will take less pressure off the Cdn$, because the US will not be raising interest rates as aggressively. We are left with a slow growth environment, and we have to look for companies that have a catalyst, something that is unique to them that allows them to grow at a faster rate than their own historical performance, their peer group, and the economy as a whole. If you find that, along with proper pricing, then you settle into a good portfolio and be patient.

Oil. There is a risk that we will see lower oil prices over the next few months. There is the summer driving season, which is a strong period of demand. Then you go into a shoulder season of September, October and November, and demand falls by 1-1.5 million barrels a day worldwide, (maybe half that in the US). In 2014, we fell from $100 down to $50. In 2015, we went from $51 down to $35. He thinks the decline will be potentially down into the low $30. There was a 2.3 million-barrel production increase last week in crude stocks, 4.5 million-barrel in overall stock, and the week before it was 2.6. There should not be inventory building now, it should only start the 2^nd week of September. He is bearish on oil prices for the next quarter.

Markets. He is meeting a lot of super cautious people that think the end of the world is coming. When the market is undervalued and the individual investor is afraid to put their money to work, private equity steps up, the corporations step up and jump into the void and take advantage of that. The last time we were at these valuations, interest rates were 5% higher than they are now. If you apply Capital Asset Pricing Models (CAPM), multiples should actually be quite a bit higher. Because of that, you could make that the market is undervalued. Companies are looking at this and can borrow money at very low interest rates to make undervalued acquisitions. Investors don’t have to Buy the market. There are a bunch of stocks that are trading at single digit PEs, so you are not paying up for the stuff. It people are willing to spend the time, dig and find the value they can outperform the market over the long-term.

Market. Thinks the market is still positioning for rate hikes this year and that the Fed is going to do their best to get one hike in this year. The US$ is the one chart to watch, because it is such an important indicator of the global macro trend. If the US$ is going to strengthen like it did in advance of the rate hike, that could put pressure on crude oil, commodities and Canada. We have reached peak dovishness in terms of interest rates. That has pushed all the bond look-alikes, utilities, REITs, telcos, etc. to very high valuations. His biggest concern is more sector risk. When valuing stocks, he looks for 3 things; price momentum, valuation and volatility, and wants to buy stocks that have the best combination of those 3.

REITS. The sector is up 16% year to date. August was a bit of a dip. There is a fair amount of interest coming into the sector. In September REITs will have their own sector and won’t be under “Financials” any more, and he thinks there will be a bit more interest. Any surprises, of rising rates, is going to put negative pressure on the REIT sector. However, if there was a dip, he would be buying into it.

Markets. He does not focus on dividend yield so much as on dividend growth. The US equity market has been in a profit recession for 5 quarters. First quarter this year was the worst quarter for earnings growth. But improvement in earnings for the fourth quarter is largely priced in. Telecom, utilities, energy and materials are the top sectors. He is typically in consumer staples, consumer discretionary and financials. There is a real risk in stocks with a high dividend yield.

Economy. The manufacturing number out of the US was kind of weak, and then all of a sudden people began to think maybe interest rates would not be raised in September or December. Every single data point seems to switch the market. The Fed is trying to fight unemployment and inflation. Their employment looks like it is at pretty good levels, and inflation is nonexistent. If we start to see wage inflation, that could be the impetus to put pressure on rising rates. Food in the US is at the lowest prices in years so you have food deflation. Energy prices are at low-level’s also, so the US consumer should be spending lots of money. Portfolio managers globally are not earning their returns in fixed income, so that is why people are going into stocks.

Bank preferreds? He would rather buy the stocks rather than the preferreds. There is no point in buying preferred shares because you don’t get any of the potential upside. However, he would have no problem in buying any of the big 6 banks.

Market. Doesn’t believe the US Federal Reserve will pull the trigger on an interest rate increase in September. She doesn’t expect a rate rise until the November or December meetings. We are still running well below inflation targets. The big number is going to be the jobs report this Friday. Because the rate increase has been expected for so long, if it happens, she wouldn’t expect as much of a shock or pullback in the market. In the 4^th quarter, she is expecting double digit earnings gains.

Effect of a strong US$ on the price of oil? A stronger US$ makes oil more expensive for other countries, because oil is US dollar denominated. However, the real impact is the supply chain. What might be more of an impact than a stronger US$, is foreign revenues. When foreigners want to repatriate all the money they have made, the impact is going to be less. About 40% of all revenues for S&P 500 companies come outside of the US, and could create some headwinds when it comes to Company’s earnings. $40-$50 oil does not make these companies terribly profitable. They still have another year of recovery, and she would say oil should be underweighted in a portfolio until there is some true stability in the upper $40.

Gold miners? Gold is really a defensive play. You can see it do well when we are very much in a “risk off” scenario. Right now, she just doesn’t see that on the horizon. She doesn’t see any fear in the market that would propel gold too much higher levels. Unless we see a real risk in the economy, or some sort of big shock, she would prefer staying in the equity markets.

Economy. GDP figure was disappointing today, but was a little bit of a rebound from June. A lot of the GDP numbers and data points coming out, are really supportive of this “lower for longer” self-fulfilling prophecies put forth by Central bankers. Although there is hope that we can have better numbers, but the real big issue is our export numbers. They were down considerably in Q2, and he doesn’t know if we are going to have our manufacturing sector pick up the slack. He sees a series of headwinds, that have formed and continue to form, for the Canadian economy. When looking at his total return portfolios, he is compelled to look stateside for opportunities.

Market. We have had a good move in oil and oil stocks, and thinks people are waiting for the next couple of months to play themselves out to get more conviction in terms of shorter-term direction. He’s been calling for $60 oil for next year. September is usually a poor month for energy stocks and oil. Now we have the distraction of having an OPEC meeting at the end of September, whether it be a freeze or no freeze. Whether they formally agree or not to increase production, is a bit of a joke, but the market has really gotten caught up in it. We have also seen speculative net length in oil itself, increase pretty materially and at the same time there has been a huge drawdown in the Short interest in oil. The oil price must really be high enough that allows US industry to drill enough to grow production once again.