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

Canadian banks. Feels these will not be as prosperous as they have been, especially on the reliance of the Canadian consumer. Looking at consumer debt as a percentage of household income, at some point we are going to see loan growth start to slow. As a result, the lean net interest margin that is there will start to hit the bottom line. He owns all the Canadian banks except for Toronto Dominion (TD-T) and Bank of Montréal (BMO-T), which are more heavily weighted in the US, which he is capturing through his US regional banks. You would be best off taking a weighting in each of them because they are correlated to one another. Or you could pick an ETF.

Railroads. He is not in this space which is really just a valuation play. On the Canadian rails, you are paying a big premium. He likes the space, but doesn’t think it is going anywhere. Wait for a bit of a pullback.

Markets. In the very near term, North America as well as global equities, they are a little extended according to the Relative Strength Index. In North America, both the S&P 500 and the TSX are in the 60 something range for the RSI, which is getting a bit overbought. Thinks a brief pause is in order. Those 2 indexes are trading at 18X-19X the trailing or forward earnings. This is at the higher end of historical valuation ranges. Geopolitical risks, uncertainty of the timing of rising interest rates, and the spill over of lower commodity prices are risks that he is looking at. They will cause more volatility. On the positive side, the lower energy costs will be a net benefit for the US economy, because 70% of the US economy is the consumer. Also, oil importing companies will benefit. Because of this, he thinks we will see markets grind higher in the US and other parts of the world. A Buy on Dips mentality still makes sense.

Markets. You want to be pretty selective in where you put your money and be a bit quicker to get rid of things that aren’t working for you. 3 years ago Canada was the place to be. Then she moved to the US and it was a good place to be. She is 65% in the US now. Technology continues to be her largest sector.

Cdn Markets. He thinks the TSX is going to be trading between 13,000 and 15,500. To him, the bottom of the range is more important than the top. This is where things are going wrong. The 2 risks he sees are if commodity prices stay lower for longer, and the second risk is if interest rates go up quicker than people expect. Other than energy and commodity stocks, everything is doing pretty well. To get to the top of the range, we would have to see commodity prices pick up fairly significantly. Hopes that the oil price works its way through to the companies. Expects it will take 6-12 months. As long as oil prices trend up in 12 months, the remainder of the companies in the oil patch will be okay on the dividend side.

Banks. These represent the economy and what is happening. Their domestic retail businesses pay the dividends and grow the dividends from that. Not a bad place to be, but he would suggest there are other industries you could invest in where you would get added growth. What he does, is have backbone type sectors such as utilities, pipes and telecoms. He then tries to add in some companies that are growing their dividends at a faster rate. It may be a lower yield, but growing at 10%-15%.

US Markets. US stocks are trading at about 17X earnings. Given the interest rate environment, profit margin growth and productivity trends, it is probably in fair market range. You have to look at individual sectors, industries and companies for your growth, as opposed to allowing the market itself to take you higher. With lower rates, the cost of capital is cheaper for corporations and they are more likely to make money easier, so profit growth is more easily accomplished. From a market standpoint, rates (bonds) are a competitive asset class, so when you have low rates, people gravitate towards stocks. Also, you could look at it from the point of earnings yield. If you take the P/E ratio, and invert it, E/P gives you an earnings yield which, historically, has pretty much matched the B-AA bond, the worst investment grade bond out there. Currently, there is about a 2 point spread, which means that either valuations can go higher, or interest rates will go higher. His suspicion is that both will happen. You are going to see articles that the multiple in the market is getting way out of whack, and this is going to happen in large part because energy companies are expecting to see earnings halved in 2015 over 2014. That is going to have an effect on the multiple of the S&P 500. You have to look at 2 things. 1.) Is it a transient event (which is debatable) and 2) it is isolated to energy companies and one should look at the other 9 major sectors. There is going to be lots of places to look for value.

Tax Info. One of the very big things for people who have foreign assets is the Foreign Income Verification form (T1135). This is a complicated form to complete and is required for anybody who has $100,000 of foreign assets outside of their RRSP. You can go to www.goodreid.com to E-articles to read about this.

Economy. Here we are 6 years after the crisis and not only have we had all the geopolitical problems, it is like the world has been having a huge experiment in the monetary policies. No one quite knows how it is all going to turn out. It almost seems to be a race for the bottom in currency wars the way people are lowering their bank rates. Some are even negative now. Quantitative easing is also spreading across the world. At the same time, the US$ has been so strong that it is almost like people have been cutting rates to become more competitive. At what point does the US become unhappy with this? He thinks it is beginning to seep a little bit into US manufacturing, but nonetheless their economy seems to be the one that is strong and growing. It has been the place to be the last couple of years. In Canada we have had the opposite effect through oil prices collapsing, which is also having ripple effects across our economy. As a value investor, to position yourself over the next business cycle, you have to figure out where you want to be, how you want to do it and try to figure out what opportunities are going to come from these kinds of changes that are happening. That is what he is struggling with now.

What metrics do you focus on, as to whether a stock should be classified as Growth or Value? As a value manager, he tries to judge what he is paying for against what he is getting now, and is likely to be there in the future. He is looking much more for organic growth rather than through acquisitions. If you are looking at stocks in any one industry, growth stocks are generally going to have higher multiples, whereas value managers are probably going to be buying more return on equity.

Markets. Stocks at 18X earnings on the S&P 500 sounds expensive, but it’s all about interest rates. Interest rates are low in Canada and it doesn’t look like the US is in any hurry to raise interest rates. That means that anything that drives the cash flow makes that cash flow work even more. He has lots of retired clients that need to live off their portfolios, and they are not paying him a fee plus taxes and inflation, to make 1% on bonds. They would run out of money. If you expect interest rates to stay in a low environment for many, many years, then you want to own dividend and cash flow producing assets. The best assets that he can invest in are stocks. Also, pension funds have to rethink things in order to make their payments so they need to be buying stocks. People are living longer. We all have to ditch our bonds, get rid of our preferred shares, and be in more stocks. This is why the stock market is going up and why he believes the stocks are mispriced. If you believe interest rates are going to stay low, then stocks are roaring cheap.

Gold. The simple answer on this is “Don’t Buy It”. He has no interest in gold and is not going to buy it.

TFSA accounts? This is a wonderful vehicle. Great for the young investors. If the government lets it continue and lets it grow over time, people are going to have millions of dollars in their TFSAs when they retire.

Reset preferred shares? January was not a good month for these. The terrible wrinkle on these is that they were built for a rising rate environment, not a decreasing rate environment. It looks like interest rates are to be cut again. The good news is that they have already taken their hit and if you don’t expect further rate cuts past March, then you can stick with some of them. He wouldn’t Sell, as long as you own good quality preferred shares.

Economy. With a pullback in commodity prices, the whole economy has been getting a lot of tailwinds, which has been reflected in some of the companies related to manufacturing in the US as well as retailers. Energy has affected the US equity markets such as Starbucks, fast food companies, retailing groups, which are all hitting new highs. Right now it becomes a difficult exercise to pick the winners. Valuations look stretched to him, but he thinks there is room to grow from where we are.