Inverted Yield Curve – Signal to Raise Cash and take risk off the table

US yield curve turned negative on Friday for the first time since the last recession of 2007.

This has occurred every time before the last eight recessions since 1968

Economic growth continues to fall sharply in both China and Europe

An inverted yield curve where 10 year Treasury rates fall below 3 month Treasury Bills, implies that investors are losing confidence in the economy

If this inverted yield curve persists, banks will materially reduce lending as it becomes unprofitable with a negative spread

US / China trade wars continue without any clear signs of compromise from either side

The probability of an economic recession within the next 12-18 months has increased significantly from last month


While it is still too early to be 100% certain of an impending recession, it is critical to take risk off the table at this time

The recent market rebound has provided us with an opportunity to do so

Raise cash if you have not already done so

Maintain high cash levels. My Income and Growth sample portfolios have 35% and 30% cash respectively

Reduce cyclical equity sector exposure including financials

Increase equity weight to the more defensive sectors including utilities, Reits, consumer staples and telecoms.

Northland Power – Buying opportunity

New secondary offering has taken the share price down by 10%

Current market price of $23.16 is below issue price of $23.35

Secondary issue has no effect on treasury stock – no dilution

Chairman is selling a large chunk of his stock for estate planning purposes

Company has strong projected growth in cash flow and earnings over next two years – better than average of its peers

Stock is attractively priced at current levels relative to peers at 14.25 PE on this year’s eps

Current dividend yield of 4.66% with reasonable payout


Parex Resources – Positive Fundamentals

Parex’s share price has been one of the best Canadian energy stocks both year to date and in 2018.

Year to date its total return is up almost 26% vs 7.6% for the iShares XEG ETF.

Even in a bad year last year for energy stocks, Parex only fell 10% vs a 27% decline for the XEG sector benchmark

The company receives the higher Brent crude prices

Parex has a strong balance sheet with no  debt and working capital at the end of last year of $215 million US

Proven and probable reserves rose 27% last year

The company has strong self funded organic production growth

The company is expected to report its quarterly earnings this week.

While the shares are not cheap relative to its peers, the company continues to deliver strong results



Chartwell Retirement REIT – Headwinds

The long term demographic trend of an aging population remains positive for Chartwell

However the immediate supply / demand outlook is only in balance with no supply shortages anticipated

For Chartwell’s top markets – Ottawa, Durham region of GTA and Calgary, the company is actually experiencing an oversupply of product

As a result of these current headwinds, Chartwell will only be able to increase their dividend distribution modestly

Conclusion: Favour both apartment and industrial / logistic REITS more than retirement homes as they have better industry fundamentals.

Switch out of SNC into Aecon Group

The Public Prosecution Service of Canada announced that it would not allow SNC to negotiate a settlement in regards to past corruption charges. This means that SNC will have to go to court to settle this charge and this may take quite a long time.

In the interim the company will not be viewed in a favourable light by the investment community as this creates a lot of uncertainty.

After its recent sharp price decline the stock is now trading at a substantial discount to its peers.

The company does become a takeover target at these prices.

However should the company lose its upcoming court case, it would be banned from bidding on government contracts for up to ten years.

Aecon Group has a strong order backlog and solid 3% dividend with a low payout.

The company is experiencing good cash flow growth.

The company was recently awarded a 50/50 joint venture to construct Trans Canada’s new  pipeline to transport natural gas to the LNG facility in Kitimat. This contract is worth $263 million to Aecon.

Removal of Dollarama from Growth portfolio

  • Company has seen 2 consecutive quarters of declining same store sales growth rates
  • According to the company, this trend is expected to continue
  • Company has decided to limit price increases as a result of more competition
  • Stock is still trading at over 25 times earnings compared to only 14 times for Canadian Tire
  • The projected earnings growth rates are similar for both Dollarama and Canadian Tire
  • Canadian Tire offers much better value relative to their earnings growth
  • Dollarama’s share price has rebounded 7% from its recent low, making this recommendation a little less painful

Shopify – Adding back common shares to Growth Portfolio Technology Sector

  • Latest quarter saw revenues up 62% year over year
  • Remains one of best positioned companies in application software
  • Remains closely associated with Amazon, differing from their competitors
  • Continues to outperform its peers
  • The share price is still off over 18% from its recent high despite today’s strong rebound
  • Aurora Cannabis has recently signed an E-Commerce deal with Shopify to sell both medical and recreational cannabis
  • While the shares still look expensive using traditional valuation parameters, Amazon also perplexed investors from its infancy by not reporting any profits for many years.
  • We all know how well Amazon is doing now



US Protectionist Trade Policies Escalate

Today the US Administration has slapped import tariffs on steel and aluminium from Canada, Mexico and the European Union.

Both Canada and Mexico have retaliated by implementing their own import tariffs on a dollar for dollar basis.

These events make any NAFTA renegotiations much less probable.

Nobody wins in a trade war.

Short term effects are higher domestic inflation globally and a lower loonie.

Justin Trudeau has exhibited very strong leadership this week both on the Trans Mountain pipeline issue and by retaliating from the US punitive tariffs.

Removing Sienna Senior Living from both portfolios

A class action lawsuit was recently filed against Sienna and Extendicare for failure to provide proper care in some of their Long Term Care facilities.

While any possible settlement will be paid for by their insurance protection, this will lead to an increase in government intervention.

More government regulation in the Long Term care area will lead to higher costs and even lower operating margins.

All industry players will be attempting to diversify away from Long Term Care into the higher margin Retirement Home segment.

Even after their recent acquisition in the Retirement area, Sienna will still derive 56% of their net operating income  from their lower margin Long Term Care facilities.

I have just reduced my REIT exposure to 1.15% of the total North American equity exposure and selling Sienna will help to accomplish this objective.


Equity Sector changes – Increasing Energy to Market Weight

  • 2018 global oil demand expected to continue to outpace global supply, despite rising US shale production
  • Almost 50% of global supply is subject to restraint
  • Total oil stocks have been falling steadily since May of last year and are now very close to five year average levels
  • Energy sector is very underowned in both Canada and the US
  • Equity sector rotation into cyclicals is happening now
  • Energy sector weight for TSX is 18.5% and for S & P 500 is 5.7% in April
  • Using my 60% US and 40% Canada exposure, the benchmark weights are 10.82%
  • My recommendation is to increase the weight to 10.82% benchmark from my former 9%

Adding Vermilion Energy to both portfolios

  • Vermilion currently pays a dividend just shy of 6%
  • The company did not cut the dividend in the last crude price downturn
  • Vermilion has just made an offer to acquire Spartan Energy, a light oil producer in Saskatchewan for $1.4 billion
  • The purchase will be immediately accretive to Vermilion as Spartan is trading at a much lower valuation
  • Analysts do not expect another competing bid for Spartan as there is a $40 million breakup fee if the deal falls through
  • This purchase will add an additional 23,000 barrels per day of oil equivalent taking its new output to 95,000 barrels per day
  • Vermilion currently operates in France, Holland, Germany, Ireland and Australia where it receives the higher Brent crude price

Trade Wars – Nobody wins

  • 1929’s US trade protectionist policies extended the Great Depression by ten years
  • Trade Wars result in domestic inflation
  • Positive effects of US tax reform muted by threat of trade wars
  • Robert Shiller, an American Nobel laureate and Yale economics professor, said that US  trade wars with China would result in an economic crisis if they continue to escalate.
  • The US needs China to help negotiate with North Korea in regards to their nuclear arms
  • The US needs China to continue buying their government debt to finance the American’s massive $1 trillion annual budget deficit.
  • The ongoing trade rhetoric between China and the US will get worse before any agreement is reached

Buy US Bank Stocks

  • Rising interest rates are resulting in improving net interest margins
  • The strength in the US economy helping to propel both mortgage and overall loan growth higher, while keeping default rates low
  • The recent pickup in market volatility will lead to stronger capital market profits
  • Rising security markets positive for wealth management divisions
  • Less Government Regulations will improve profitability

Trump’s new import tariffs a threat to global growth

  • Trump imposes massive steel and aluminium import tariffs
  • This is a threat to global economic growth, affecting Canada and the European Union as much as it does China
  • May lead to a global trade war with other countries imposing import tariffs on US exports
  • US protectionism will lead to higher domestic prices and rising US domestic inflation
  • This can mitigate all the positive growth drivers from US tax reform

What to do after recent stock market selloff

Use recent market drop to increase equity exposure

  • Restrict new purchases to US equities
  • No signs of an impending recession.
  • Market Valuation correction only

Headwinds affecting Canadian equities

  • Ongoing NAFTA uncertainty
  • US corporate tax reform makes Canada less competitive
  • Canadian pipeline disputes between BC and Alberta causing Western Canadian Select crude prices to trade at a very large discount relative to West Texas Intermediate
  • Crude prices trending down once again on increasing US shale production

Reduce Canada’s North American equity weight to 40% with the US increasing to 60%

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