Stock Valuations not Significantly Above the Long-Term Average

Our strategy in effect remains unchanged.  As major stock indices fall in the 10-20% range we will accumulate growth stocks in the U.S. and Canada.  Favoured sectors and some of the names we have added recently include technology/media (CGI, Open Text, Avigilon, Google, Apple, Microsoft, Facebook, Disney), transports (CP Rail, Fedex, Transat) and financials (ScotiaBank, National Bank, CIBC, JP Morgan, Citigroup).  We are also seeing some opportunities in the Energy sector.  We expect that reduced capital spending will slowly curtail oil production at the same time as energy demand is expanding at the fastest rate in over 10 years.  Although oil prices may trade below US$40 again in the short term, we expect prices to recover into the US$50-60 range over the next year.  Energy companies with strong balance sheets and low production costs should easily survive this downturn and yet many of the stocks are down more than 60% in the past year.  Companies such as Canadian Natural Resources, Suncor and Crescent Point look attractive now among the senior names while Gran Tierra Energy, Whitecap Resources and Trinidad Drilling look good in the mid-sized and service sectors.

The preferred share market has been weak in 2015, and the selloff has accelerated recently. The index has lost over 20% since the start of the year and a lot of investors are wondering what is going on.  In terms of the recent selloff, a number of factors have been at play:

The downgrading of Enbridge preferred shares’ rating in June has led to forced selling by investors and advisors who have limits on the amount they can hold.   Enbridge issues make up more than 8% of the Canadian preferred share market.

The disappointing Canadian economic data has increased speculation that the Bank of Canada will cut interest rates again.  When the Bank lowered rates in January by 25 basis points, the yield on 5-year Canada Bonds dropped 75 basis points.  That led to significant weakness in issues that would be resetting their dividend rates in the next two years.  In the last couple of weeks, the 5-year Canada yield has fallen and that has caused concerns that the rate reset issues would fall in value again.

A number of US dealers have been among the largest sellers of preferred shares.  That is unusual, and one theory as to why they have become active in the Canadian preferred share market is that one or more large hedge funds has decided to short the Canadian banking sector via their preferred shares.

Momentum and small retail investors have been selling somewhat aggressively in order to raise funds due to overall stock market weakness without much concern about valuation.

While market corrections are unpleasant events, they also create opportunities.  We remain fundamentally bullish about preferred shares.  We have been adding to preferred share allocation to client portfolios for a number of reasons:

  • The yields on preferred shares are very attractive, with most over 5.00%.’
  • There has not been a significant deterioration in the creditworthiness of preferred share issuers.
  • If the Canadian economy has indeed slipped into recession, it is a shallow one centred in the resource sector, while other significant sectors of the economy continue to grow.
  • Our actively managed Canadian preferred share fund portfolio has suffered substantially lower losses than the market and has been positioned to benefit from a recovery in the sector.

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