Global malaise buffets markets here

Even though the U.S. managed to avert its “fiscal cliff,” which would have pushed its economy into recession, Carlin still fears that the country’s gross domestic product (GDP) growth in 2013 may be only around 1%. “This is the reality,” he says. “[The U.S.] may slip into recession. But we don’t think [it] will because [the U.S. government has] some levers to adjust spending or taxes.”

Meanwhile, economic prospects are poor in Europe because the austerity programs there have pushed the weaker European Union members into recession.

Conditions are more favourable in China, the economy of which will avoid a so-called “hard landing.” “[China is] trying to slow inflationary pressures, which it has accomplished,” says Carlin, adding that China’s government benefits from a relatively strong balance sheet and a low debt/GDP ratio. “Now, [China is] on the next leg, which is slower, steady growth. A lot of its growth will come from internal consumption. But we’re OK with the outlook.”

From the perspective of the Canadian stock market, Carlin is cautious about 2013 and expects earnings growth of about 5%, in contrast to the consensus expectations of 16.8% earnings growth. Based on Carlin’s view that inflation is tepid and interest rates are likely to stay low, he says: “The stock market is reasonably valued, at about 12 times earnings.”

A bottom-up stock-picker, Carlin has about 74% of the imaxx fund’s assets under management (AUM) in stocks, 20% in bonds and 6% in cash. Of the fixed-income portion, about 18% is in provincial and federal government bonds, with 82% in investment-grade corporate bonds from issuers such as Enbridge Inc., a leading North American pipeline company, and BCE Inc.

On the equities side, the imaxx fund has about 26% of AUM in energy, 24% in financial services, 18% in real estate investment trusts (REITs), 12% in materials and smaller weightings in sectors such as industrials.

Enbridge also is a top holding in the equities component (which contains about 35 names) of the imaxx fund. “[Enbridge stock] has a 2.9% dividend yield,” says Carlin, “and 10% per annum visible earnings growth to 2016, on the basis of $18 billion of new projects.”

Enbridge stock is trading at about $43 a share. Carlin’s target is about $46 within 12 months.

Some of the obstacles facing investors aren’t likely to change, says Rob Lauzon, managing director, Western Canada, for Middlefield Capital Corp. in Calgary and portfolio manager of Middlefield Income Plus Class Fund.

“Most countries in Europe are in recession or teetering on recession, although that will change over time,” says Lauzon, adding that Europe will “muddle along” as authorities bring the debt crisis under control and try to quell the sporadic public protests. “The only way they can resolve the debt problem is through austerity and some increase in revenue, which typically comes from higher taxes. It will take a lot of restraint by Europeans.”

On the other hand, Lauzon believes that signs of a soft landing in China are starting to emerge. “[China] slowed the economy at a time when Europe has been very weak, so China has slowed more than hoped,” he says. “But we are seeing [better] manufacturing indices and the purchasing data start to bottom. We’re encouraged that maybe we’ve seen the worst.”

Meanwhile, in the U.S., Lauzon anticipates a positive outcome regarding the fiscal cliff – equal to 25% or 33% of the original proposed spending and tax cuts. “That,” he says, “will remove the risk of a near-term recession.”

The global malaise has been a drag on Canadian equities markets, says Lauzon, but Canadian bonds have become expensive, he says, given that 10-year government bond yields are down to 1.8%.

“The TSX composite index has a 3% yield, or about 1.2 [percentage points] higher than government bonds,” he says. “Dividend-paying equities look far more attractive than they have in a long time.”

From a strategic viewpoint, Lauzon has allocated about 30% of the Middlefield fund’s AUM to fixed-income, 64% to stocks and 6% to cash. Lauzon has a payout target of 5.5% per annum, a portion of which is delivered through a mix of high-yield bonds and convertible debentures.

Among the high-yield debt held in the fund are issues from drilling contractor Savanna Energy Services Corp., which yields 6.4%, and grain handler Ag Growth International Inc., which yields 4.7%.

Within the growth-oriented 35-name equities portion of the Middlefield fund, Lauzon favours the energy sector, which represents 27% of equities AUM, followed by real estate (9.5%), telecom services (6.2%) and smaller weightings in areas such as utilities.

“Energy is the biggest business in the world, with lots of opportunities,” says Lauzon. “[Because] it’s harder to find new hydrocarbons at cheap prices, the cost curve is rising. So, it’s a great place to invest.”

Still, Lauzon has adopted a barbell approach and split the energy exposure between utility-like names, such as Pembina Pipeline Corp., that pay a steady 5.6% yield and dividend-paying producers that have some upside, such as Crescent Point Energy Corp.

Crescent Point stock is trading at about $37.60 a share and has a 2.7% dividend yield. Lauzon’s share price target of $45 in 12 to 18 months.

Another favourite is Brookfield Office Properties Inc., which has interests in more than 100 properties in major downtown centres in North America. Its stock is trading at about $16.90 a share, and pays a 3.2% dividend. Based on a net asset value of $20, Lauzon believes the shares have 25% upside.

In discounting some of the major worries, such as a possible economic slowdown in China, North American markets have seen broad weakness across many sectors, says Peter Frost, vice president and Canadian equities portfolio manager with Toronto-based AGF Investments Inc. and co-manager of AGF Monthly High Income Fund.

“There was a slowing down of the economy in the third quarter [of 2012],” says Frost. “We have seen a fairly strong sell-off in equities markets, both by companies with strong returns and those that have not done well. Some investors are locking in their gains in anticipation of possible tax hikes. But I’m finding good companies that are being sold off indiscriminately.”

Frost and portfolio co-manager Tristan Sones, vice president at AGF, who oversees the fixed-income portion of the AGF fund, argue that 2013 will be a stock-picker’s market, on both the equities and fixed-income sides. Says Sones: “You won’t have an environment in which all boats get lifted at the same time. It’s going to be company-specific, which will be the alpha contributor.”

Frost notes that every successive round of quantitative easing in the U.S. over the past four years has produced shorter and less powerful rallies. “That’s why,” he says, “security selection is going to become very important.”

From a strategic viewpoint, about 48% of the AGF fund’s AUM is in Canadian stocks, 12% is in U.S. equities, 5% is in international equities, 25% is in fixed-income and 10% is in cash. The bulk of the fixed-income weighting is held in about 30 high-yield bonds from issuers such as U.S.-based autoparts maker Meritor Inc.

Within the equities allocation, Canadian energy accounts for 27% of AUM and financial services, 21.3%. “The banks are fully valued,” says Frost, “and will struggle for growth, mainly because the Canadian consumer is highly leveraged. And after a huge real estate boom, mortgage formation will start to slow.”

The AGF fund’s equities holdings include 10.9% in consumer staples, 9.1% in industrials and smaller exposures in sectors such as materials.

Frost looks for firms that have a 5%-plus yield with a good possibility of increasing that yield. One favourite is Chartwell Seniors Housing REIT, which was hit by the U.S. housing downturn and experienced a decline in occupancy rates. “But we’ve seen an improvement [for Chartwell] in the U.S. and Canada, too. And [its] existing properties are growing their operating income,” says Frost, adding that Chartwell’s balance sheet has improved and the firm has benefited from opportunities to expand in a fragmented market.

Chartwell REIT is trading at about $10.90 a unit and has a 5% yield. Frost’s target is about $13 in 12 to 18 months.

Frost also likes Brookfield Infrastructure Partners LP, which owns toll roads, utilities and shipping terminals in countries such as Chile and Australia with long-term, inflation-protected contracts. “[The firm’s] cash flows are growing by 3%-7%,” he says, “and [it] continues to acquire new assets.”

Brookfield IP’s dividend yield is 4.2%, and its shares are trading at about $35 each. Frost’s target is $38-$40 within 12 to 18 months.

© 2013 Investment Executive. All rights reserved.