Video - Market Trends February 2015

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Economic and financial outlook by Michel Doucet, Anne Perreault and Jean-René Ouellet.

Michel Doucet, B. Sc., GPC, Vice-President and Portfolio Manager, Portfolio Advisory Group;
Anne Perreault, M. Sc. Finance, CFA, Portfolio Manager, Portfolio Advisory Group;
Jean-René Ouellet, MBA, CFA, GPC, Portfolio Manager, Portfolio Advisory Group.

Market Trends – February 2015

Michel Doucet:
Hello, and welcome to our quarterly webcast, which will enable you to learn more about financial market trends, to keep up with the trends. Anne Perreault and Jean-René Ouellet are joining me.

Three themes that we’ll be covering this morning. The first one is the economic outlook. We’ll be talking about the U.S. economy, Europe, emerging markets and also Canada, monetary policy, what’s the Fed doing as the Bank of Canada surprised the market with a rate decrease in late January. What’s up with resources? Anne, there’s one thing that everyone is talking about, it’s the buzz of the town: where are oil prices going and what does it mean for consumer?

Anne Perreault:
Yes, Michel. Generally, prices reflect the balance between supply and demand. With the sharp drop in the price of oil, it’s normal to wonder about the size of the gap between supply and demand. According to forecasts, the market is likely facing a surplus of about 1.5 to two million barrels per day in 2015. This may seek like a lot, but it represents only 1.5 to two percent of global oil consumption. However, the extent of this imbalance could change quickly.

For example, Nigeria, Iraq and Libya together produce six million barrels per day. As we know, these countries are all faced with political instability. A supply disruption in one of these countries would affect the surplus level.

In addition, it’s important to note that the imbalance is not due to a slowdown in demand. In fact, according to the International Energy Agency, demand for oil should increase by one percent this year. Production is growing faster than demand. The cause? U.S. shale oil whose production has risen in the space of a few years from five million barrels per day to more than nine million.

Until just recently, Saudi Arabia played the rule of swing producer, which means it adjusted its oil production to maintain – to maintain a price balance. This time, it decided to act otherwise to protect its market share. But these strongarm tactics come at a cost for this country which derives about 80 percent of its revenue from the oil industry. However, Saudi Arabia has accumulated approximately 700 billion in foreign currency reserves, which gives it some latitude.

At current levels, oil prices should have an impact on production. Most wells already in operation will probably continue to produce because of the fixed costs that have already been paid and the debt to be paid. However, spending on new developments should fall considerably, which suggests a slowdown in production beginning in 2016.

So we can expect oil prices to eventually recover. Further, in 2015, it’s not excluded that on a daily transactional basis the price of oil can be traded between 40 and 60 dollars.

On a more optimistic note, Michel, the drop in the price of oil has an upside. For households, it translates into an extra 500 to 700 dollars per year.

Michel Doucet:
Taking your forecast to the word, this is great news for Canadian consumers. If I have to look at the Canadian economy, we’ll go on the one hand, on the other. On the positive side, the acceleration of the U.S. economy. Second, the weakness of the Canadian dollar. Thirdly, low price at the pump. If your forecast actually holds the road, this means more money in the pockets of consumers, which they will eventually spend. And the last piece of news on the positive side is the surprise move by the Bank of Canada which lowered interest rates at the end of January.

On the other hand, on the negative side, lower oil prices will also mean a slowdown in economic activity in Alberta and will also take its toll on public finances at the federal level and the provincial level.

To that we have to add the fact that households are in debt. Household debt burden is currently at record levels. Overheated housing market. If you put Australia and Canada together, two countries that netly benefited by the boom in natural resources in the 2000s, both these countries have seen their debt level, their household debt level went up the roof. Same thing you can see at home, prices have also went out of the stratosphere. This is a challenge that will have to be met by consumers. When? That is the big question.

Also worrisome to investors is with lower interest rates over the years, some have taken more risk that maybe they can have in their portfolios. These are concerns that we will have to think about as time goes on.

Jean-René, as I mentioned, the Bank of Canada surprised us at the end of January with a rate decrease. Another one is probably in the offing anywhere between now and the end of the first semester. What about the ECB? What happened in Europe?

Jean-René Ouellet:
Well, no one has been surprised by the ECB because it was expected for 18 – more than 18 months now, but they finally delivered. And once – have to remember that once the Fed took control in ‘09, things started to improve and get better, and we never looked back. So today, we have a European Central Bank that is taking care of the situation. With the low rates that they push the market for, it will be easier for sovereign to get access to easy financing. It will give them times to make the proper structural reform that they need to deploy, and also the lower euro will mean that the whole zone will become more competitive on the international basis.

It looks like – the euro zone looks like the U.S. in 2009. After hitting a wall in 2009, the U.S. consumers had taken too much debt, relied too much upon his houses to make expenses, use his house as an ATM. Over the last few years, restructure the debt, refinance at low rates for fixed terms. Now the debt service is at a record low. Their financial asset did improve in values. Houses prices have recovered. And we all remember that net worth of U.S. households did decline in ‘08, ‘09 and so on, but we forgot to look forward and now the U.S. household net worth is hitting new high, new record high. So their balance sheet has been reshaped.

And if we take it a step further and we look at the labour market, it is also improving. We took the unemployment rate, we cut it by half. We look at the wages, and they’ve started to increase once more. They’re not skyrocketing here, but things are improving as we see the labour market tightening. We see demand for new employees reaching 14-year highs, job cuts are pretty minimal. So we see things getting better. And as wages do improve, people get new jobs. They turn out to be more confident and spend a little more. So the U.S. consumer is getting in better shape.

Now we have to turn to the U.S. stock market, and we can talk about the economy, but in the end we need to know what are the investment, the perspective and what could we expect in terms of return.

First, before talking return, let’s talk about valuation. If we look at PE ratios or price to book ratios, valuation doesn’t look that attractive nor that cheap. It looks essentially kind of fair. But when we take the valuation of the equities and we compare it to other asset classes such as fixed income product, well, they look quite good. When we look at where we trade right now, we have a stock market that is trading at about 15, 16 times earnings. When we’ve bought in some – in other markets in time that were trading at these multiple, what we can expect, what history shows us is that we can expect a general return between six and seven percent in real terms, which may not seem like a lot compared to the five-year, 25 percent annual – annually compounded that we’ve just produced, but once again, when we look at our asset classes, six, seven percent may be quite interesting in fact, but – and investors will need to take its equity allocation into perspective and to consider allocation within the grand schemes of things.

Michel Doucet:
Keeping up with the trend is one thing. Putting it to work in a strategy is another. One thing that we should be thinking about right now after keeping up with all the trends that we’ve been discussing here is where does it all fit in into the asset mix.
First thing we would recommend, the cash allocation, keep a neutral stance. You said that the stock market was okay, valued fairly. If ever we’d come with a window of opportunity that was to open, this cash could then be put to work in the market by increasing the share in equities that we have.

Fixed income, with the Bank of Canada coming back to the market between now and the end of the semester, again, this will be troublesome to investors. What is the best strategy? Well, maybe something we should be thinking about not to take on more risk with fixed income. An underweight strategy is something to consider.

Equities, overweight but again, if there’s a window of opportunity that would open, the market would start to rock. Maybe take that cash again and put it a little more to work in the equity section. More specifically, where would you go? In which country should we be investing?

Jean-René Ouellet:
Yeah, Michel, when we look at geographies with economies that are growing at different paces right now, we would overweight the U.S. market. We would also overweight the European market once we get protection for currency risk there. We are neutral on the emerging market, but we would divide the emerging market in two subgroups. We would avoid the emerging market that are essentially commodity producers, meaning Russia, Brazil, South Africa and so on and so forth. And we will focus more on good manufacturers such as China, India in general.

We would also underweight Canada for the economic projection that you just described, but we – investors will need to be specific into a strategy in Canada. Anne, can you tell us more?

Anne Perreault:
Yeah. As far as recources are concerned, we recommend an underweight position. Pending a stabilization and normalization of prices of oil, we favour integrated producer. That is oil companies that produce, refine and sell to customers. We are looking for companies that have strong balance sheet, low operating costs and that are disciplined when it comes to capital spending.

Also in the resources sector, we favour fertilizer producers. The global demographic trend is favourable for the agricultural sector. Companies in the fertilizer space will benefit from this growth.

We recommend a neutral position in the consumer sector. In the consumer staples segment, the outlook is favourable with a decrease in competitive pressure. The opening of new stores by big U.S. chains has slowed considerably, and some, like Target, have even closed their doors. In addition, food retailers are able to raise their price to absorb the highest cost of food. Our neutral stance takes into account the improved fundamental outlook for businesses in this sector, but it also reflects the relatively high valuation that already discount profitability growth.

For the industrial products and technology sectors, we recommend an overweight position. North American economic growth is accelerating, and businesses have trimmed their spending in recent years, so capital spending in industrial products and technology should increase, which will have a positive impact on this sector.

In the interest rate – sorry, in the interest sensitive sector, we recommend maintaining a neutral position. We’d favour life insurers first because of their low valuations, and second, because these companies should benefit from strong growth in wealth management.

Jean-René Ouellet:
If we take it to the U.S., south of the border, we also favour the industrial and tech sector where – considering where we are in the cycle, these should pose better numbers. They have lower than market valuation multiples, so we expect good numbers, and we still have even more opportunities in the U.S. than in Canada in these sectors, so that could be taken into account as well.

Second, on the consumer sector, we split between consumer staples where we would be a little more defensive and less exposed because some of these companies have pretty rich multiples right now. Yes, they’ve been popular because of their high dividend, but they face lower or slower revenue growth and profit growth, and they face very strong headwinds with the U.S. dollar being so strong, the overseas profits will be reduced for what will be published in the U.S. So careful with the consumer staple stocks in the U.S., but we would rather favour the consumer discretionary names because with the U.S. economy improving, with the decline in the gasoline at the pump, with the improving labour market, all this makes – means people have more money in their pocket to make discretionary spending, so we like this sector a little better.

In the U.S. also, we take a neutral stance on the interest sensitive sector, but we would favour lifecos as the Fed is getting near its first rate hike, maybe in the second half of this year. The normalization policies should bring good news for the U.S. lifecos. We should also expect good numbers from the banks south of the border as the U.S. consumers has reshaped their balance sheet.

And we take a very, very limited approach to the – to exposure in the resources space. Why not take the Canadian part of your portfolio to do so? So in a U.S. portfolio we should have limited exposure or no exposure at all to the resources sector.

So that is about it for equity investment, but one needs also to be specific within the fixed income area, which is challenging these days. Michel.

Michel Doucet:
Challenging is one word. I’d like to use mind-boggling. The fixed income environment is on the one hand you’ve got the U.S. stopping its QE program. On the other, you’ve got Europe and Japan, which are pumping up the pump to start their economy, and you’ve got – in the middle you’ve got the Bank of Canada that just lowered rates. So where do investors go?

If you’re an active investor, you will favour a neutral stance toward the short, mid and long-term maturities. If you’re a passive investor, something that you will certainly consider is to overweight short-term maturities in a portfolio, maturities ranking for one to five years. In there, you will put provincial bonds and municipal bonds. If you want to put some oomph into the portfolio, maybe you will increase the share of corporate bonds that you have, but again, you’ll keep them really short term, on the one hand. And on the other, you’ll certainly want to work with large corporations with great ratings.

But Anne, let’s say let I’m looking for a little more yield in a portfolio. I’m looking for the fiscal advantage of preferred shares. What would you do?

Anne Perreault:
So in 2014, preferred shares had an excellent year, but since the beginning of 2015, the preferred shares universe has lost a little more than three percent. The surprise 25 basis point cut in the Bank of Canada’s K rate is what triggered this drop. In this environment, I continue to favour rate reset preferred shares with high premiums and a far off reset date.

But know that it is often in a volatile market that the best opportunities can be found, and particularly in the Canadian preferred share market, which is marked by low liquidity and limited efficiency.

Michel Doucet:
Keeping up with a trend is one thing. Putting it to work in a strategy that will meet your needs is another. First things first. You, who are you? What are your needs? What is your risk tolerance? What do you want to do in life? This is the first thing.

Number two, let’s put that to work in a financial plan. What is – let’s define your investment profile. Let’s look at your asset allocation, your strategic allocation, your tactical allocation. Let’s then look at the investment outlook, which is what we have been doing for the past 15, 14 minutes here. And finally, building your portfolio, building a portfolio that will follow you in time, that will be your mirror of life.

Finally, our commitment is to follow this portfolio, is to make sure that, again, it is the mirror of who you are today and who you will be tomorrow.

A long-term view together with investment diversification and portfolio rebalancing is an effective combination to add value and weather periods of volatility. Resisting the temptation to react on the spur of the moment and acting when opportunities arise is part of a sound management process that has proven itself over time and through investment cycles.

We thank you for your attention, and we hope the topics covered in this webcast were of interest to you. Should you have any questions, do not hesitate to contact your investment advisors who will be pleased to answer all your questions.

Please join us for our next webcast three months from now.

Thank you and good day.


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