Category Archives: Blog Post

US flattening of yield curve – Is a recession imminent?

Spread between 2 and 10 year US Treasury yields has narrowed to 55-60 basis points

Historically a negative yield curve, where 2 year rates exceed 10 year ones, leads to an economic recession  within six months

However this time things are quite different.

Demand for US treasury bonds is very strong in a world where global rates remain very low

Chinese Government continues to invest in mid to long treasury bond maturities and this has led to yields on longer term maturities coming down

US Federal Reserve has begun increasing short term rates exacerbating the flattening of the yield curve

Current flattening of the yield curve is more a result of the current supply / demand picture for US Treasuries and not a predictor of an impending recession as has been the case historically

Investment Grade US Corporate Bond Spreads remain historically low, indicating a strong economy with no signs of a recession

Inflationary expectations remain historically low as a result of many factors including technological improvements in all industries leading to automation, deflationary pressures from Amazon and food price deflation

Should US Corporate Tax Reform be approved by both houses, this will provide a long term economic stimulus.  It is too early to tell at this moment if tax reform will lead to a pickup in inflation.

Conclusion

The probability of an impending US recession remains low at this time

How have some of my stock picks performed over the last 12 months?

As my newsletter has been going for over a year, I would like to point out how some of my picks have performed.

Most of the following companies and ETF’s I have recommended for the entire time, while some have been added later.

If the companies had been held for at least one year, the total return (income plus capital growth)  would have been as follows:

Security 1 Year Total Return
Shopify 142.9%
Nvidia 130.7%
Aphria 67.7%
Apple 59.0%
Facebook 48.9%
Amazon 47.2%
Centennial 40.3%
Stanley Works 39.7%
T.Rowe Price 35.9%
Pure Ind 35.9%
Home Depot 34.4%
Alphabet 34.0%
Bank of America 33.3%
Blackrock 31.5%
Visa 30.7%
JP Morgan 28.5%
XEC 28.4%
Cdn. Apt. 27.6%
Canadian Tire A 24.6%
JNJ 24.0%
Freehold 23.7%
WSP Global 23.6%
Fortis 21.6%
ZEQ 20.8%
HPR 20.7%
TD 20.0%
Pembina 19.6%
General Dynamics 19.6%
Manulife 16.6%
Sleep Country 15.8%
RBC 15.6%
Emera 12.5%
CP 10.8%
Chartwell 10.1%

I also took profits during the last year in both Dollarama and ZCL Composites with returns far exceeding the TSX Composite.

In regards to my sector bets, I have been overweight Financials and Technology and underweight Energy for the entire time.

Both Financials and Technology have sharply outperformed their respective benchmark domestic indicies, while Energy has under performed for the entire period.

I have also been overweight Industrials for the last year with Canadian industrials outperforming the TSX while US Industrials marginally under performing.


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Understanding Financial Statements – how to benefit

Want to Improve your Investment Performance?

Check out my presentation: Understanding Financial Statements

Learn the differences in accounting between:

  • GAAP vs NON GAAP in the US and IFRS vs ADJUSTED in Canada
  • Ensure that year over year earnings comparisons use an apples to apples approach
  • Make sure that non recurring gains and losses are excluded in earnings assessments
  • How to Interpret both Operating and Free Cash Flows
  • Dividend Payout Ratios – Should you use Earnings or Cash Flow
  • Stock Buybacks – Financial Engineering to improve EPS, but not Net Income

Add Abbott Labs and Guggenheim US Industrial ETF RGI

Adding two new US equity positions to both my Income and Growth Portfolios

Abbott Labs, symbol ABT,  is a well diversified health company with exposure to medical devices, nutrition, diagnostic and pharma areas.

It has recently acquired both St. Jude Medical and Alere and expects these acquisitions to be accretive to earnings.

Abbott is experiencing strong growth in earnings, operating and free cash flow.

In addition the company has a very long history of increasing dividends. Currently its cash dividend payout is just under 54%, well down from the 90% a few years ago.

The company is trading at a reasonable valuation of just under 20 times 2018 earnings taking into consideration its solid and well diversified growth prospects.

I am also adding Guggenheim equal weight US Industrial ETF to increase my exposure to the industrial sector that is a beneficiary from strong global growth.

Guggenheim’s Industrial US ETF, symbol RGI, has holdings in Textron, Rockwell Automation, Parker Hannafin, W.W. Grainger and Robert Half International.

 

Adding Shopify back to my Growth Portfolio

As a result of the recent 20% plus correction in share price, I am adding Shopify back to my Growth portfolio.

The stock now trades at a 12 times Enterprise Value / 2018 Projected Revenues, more comparable to its peers

However it is growing its revenues at a rate of 2.5-3 times faster than its peers.

The upcoming third quarter is expected to be very strong and will most likely result in short covering

Citron’s short recommendation was not based on fundamentals, but more on valuation.

Taking into account the high price volatility, I recommend only a small position not exceeding 1.5 – 2% of one’s total equity holdings.

Need to Diversify Equity Holdings

Yesterday Shopify was the target of a vicious and largely  unproven negative report about its supposedly aggressive sales practices.

This report was written by a well known US short seller, Andrew Left and his website Citron. It is obvious that this report was written to make the stock go down in order to make a fast buck. It should be mentioned that short sellers frequently focus on high valuation stocks that are vulnerable to a price correction.

Hopefully in future short sellers like Mr. Left and others will be investigated for slanderous research with the sole intent of making a profit.

However the lesson we can all learn from this is the following:

Never have too large an investment in any one stock. Diversify your holdings.

For high valuation stocks like Shopify, Amazon, Nvidia and others it is even more important to properly diversify by having no more than 1.5 – 2% in any one security.

When high valuation stocks experience disappointing earnings, the share price falls based on both lower earnings and a lower PE ratio.

In conclusion own at least 30-35 names in your equity component of your portfolio with any one stock representing no more than 3% of the total. In this regard you will never get into trouble and the volatility of your investments will be much lower.

 

Canada cannot give in to the Americans on renegotiating NAFTA

Canada has no choice but to fight back the recent protectionist policies of Donald Trump and his bouncer, Wilbur Ross.

Both men have achieved business success by being bullies. We all know about Donald Trump’s behaviour.

Wilbur Ross made his fortune by buying bankrupt US domestic steel companies and encouraging the president at that time, George H. Bush, to impose massive steel import tariffs directed at  Chinese steel companies. One year later US domestic steel prices rose 20% and Ross sold his company two years later for $3.5 billion.  You talk about a conflict of interest!

The more the US plays hardball in terms of trade the more other countries will be encouraged to seek  global trading partners.

Ultimately the US will not benefit from its protectionist policies. The end result is higher domestic prices combined with a loss of US jobs as international countries including Canada strike separate international trade deals and close US plants.

Yesterday the massive 219% tariff imposed on Bombardier is absurd taking into account that Boeing is also heavily subsidized by the US government and does not even offer a comparable plane to Bombardier’s.

Canada must not allow any changes to the Chapter 19 dispute resolution mechanism . The US want this clause eliminated which would result in any disputes going forward not being reviewed by an impartial panel.

Canada and Mexico are currently negotiating new trade deals with China, India, the UK and the EU.

Adding Rio Tinto PLC – ADR US$ RIO

I am adding Rio Tinto  US $ ADR to my both my Income and Growth portfolios under the Materials Sector.

Rio is a major global mining company based in the UK with operations in Australia, North and South America, Europe and South Africa.

Its production includes the following:

  • copper, aluminium, diamonds, and  iron ore
  • coal and uranium
  • borax, titanium dioxide and salt

The company offers a strong balance sheet, rising operating and free cash flows.

The current dividend yield is 4.9% and the free cash flow is more than sufficient to cover the dividend with a payout of 55%.

The company has recently decided to sell its thermal coal operation and expects to receive proceeds of $2.45 billion.

Rio is a conservative way to participate in  rising commodity markets with its strong dividend and healthy balance sheet.

 

Large Cap US High Tech – EPS Growth outlook to 2019

Comparing the earnings outlook from Dec 31, 2016 – Dec 31, 2019  for the following :

Facebook, Alphabet, Microsoft, Apple, Nvidia, Netflix, Texas Instruments, Oracle and Amazon

While Amazon is technically in the Consumer Discretionary sector, I still view this company as high tech.

The most consistent year over year earnings grower remains Facebook by a wide margin. Over the period its projected EPS growth is almost 89%.

The two fastest growing companies are Netflix and Amazon with projected growth rates over the period of 664% and 201% respectively.

The two slowest growing companies are Microsoft and Oracle with expected EPS growth rates over the period of 24% and 26% respectively.

Investors still need to compare PE valuations relative to these projected EPS  growth rates in order to make their investment decisions.

My sample Growth portfolios include Facebook, Alphabet, Microsoft, Apple, Amazon and Nvidia.

Pure Multi-Family REIT – 2nd quarter earnings report

Operating Revenues up 12.6% yr / yr

Operating Expenses up 21.2% yr/yr

Net Rental Income up 9.6% yr / yr

Average Monthly rent increase up 3.2%

Funds from Operations 7 cents, down from 12 cents last year

Dividend Payout almost 142%, vs almost 81% last year

While the fundamentals look fine, the sharp decline in funds from operations combined with the very high dividend payout does not bode well in a rising interest rate environment.

My recommendation is to sell  this REIT and use the proceeds to buy my three remaining REIT names, Chartwell Retirement, Canadian Apartment and Pure Industrial.

Canadian Apartment REIT – 2nd Quarter Results

Operating Revenues up 7%  yr/yr

Net Rental Income up 8.5% yr/yr

Average Apartment Monthly Rent up 3.5% yr/yr

Apartment Occupancy Rates 98.6%

Funds from Operations per unit  46.3 cents

Cash Distributions per unit 32.0 cents

Funds from Operations Payout ratio 69.1%

Diversifying portfolio into Netherlends

Only 6% of suites in Alberta

Only 3.7% of company’s total Ontario properties to be affected by new rent control rules affecting properties built after 1991.

Management continues to expect modest annual rent increases, while maintaining high occupancy rates.

Future rent increases combined with gradually rising dividends will more than offset the negative effects from rising interest rates.

Continue to recommend Canadian Apartment REIT.

Freehold Royalties

Freehold reported a very strong second quarter and raised its guidance for the remainder of the year.

  • Royalty Revenues up 19% yr/yr
  • Funds from operations up 32% yr/yr
  • Operating Income up 26% yr/yr
  • Net Debt down 49%
  • Average daily production up 5% yr/yr
  • Wells drilled on own land up 152% yr/yr
  • Net debt to 12 month trailing funds from operations  0.40 times
  • Free cash flow yield  6.19-6.80%, one of highest in industry
  • Dividend yield of 4.25% with dividend payout of 56% at low end of range
  • Much cheaper valuation than its major royalty competitor, PrairieSky Royalty
  • 1 year Total Return up 28%, vs. PrairieSky at 14.5% and iShares Canadian Energy ETF XEG at -8.16%

I continue to like Freehold as a long term holding.

Adding Enbridge to Income and Growth Portfolios

After its recent price decline of 9%, I am adding Enbridge to both my Income and Growth model portfolios.

The stock provides an attractive 4.66% dividend yield at current prices.

More importantly, the company has a history of rising dividends and this trend is expected to continue with projected annual dividend growth of 10-12% for the next five years.

This dividend growth is predicated on rising operating cash flows from many new projects including its recent acquisition of Spectra Energy.

Spectra Energy will provide the combined company with a more diversified balance of crude oil and natural gas distribution.

How did Wilbur Ross, Trump’s Commerce Secretary make his fortune?

Wilbur Ross has been asked by Trump to revamp NAFTA in order to benefit the US.

Despite all the opposition from Canada, Ross is proceeding to impose both softwood lumber and the newly rumoured steel import tariffs.

Who knows what industry he will target next?

Ross made his fortune in 2002 by buying up bankrupt steel companies and then encouraging the US President at the time,  George Bush, to impose a 30% tariff on imported steel.

This led to a 25% increase in domestic steel prices.

Ross sold his steel company only two years later for $4.5 billion.

This is the man that Canada and Mexico is negotiating with.

Guess who is going to win?