On the road to economic recovery

“We have seen progress being made on several macroeconomic fronts. Notwithstanding the fiscal cliff and debt-ceiling discussions, which have been partially dealt with, the U.S. economy appears to be on more solid footing,” says Hall, adding that Canada’s close ties with the U.S. should help our economy, too. “The housing market is clearly on the road to recovery. There is still a long way to go, but we’re seeing a positive contribution to the economic recovery.”

Worries about China’s slowing economy also have been a concern. Yet, Hall argues that China is experiencing a so-called “soft landing,” as its gross domestic product (GDP) growth in the fourth quarter of 2012 was 7.9%, vs 7.4% in the previous quarter. “This [soft landing] should have a positive effect on the Canadian resources sector, and we should see a stabilization of demand for materials,” says Hall, who shares portfolio-management duties with Michele Robitaille, managing director of Guardian Capital.

As for Europe, Hall expects that it will continue to struggle.

Hall anticipates that the total return for stocks this year could be 10%-15%, including 3% from dividends. “You will get some earnings growth, which will contribute to returns,” says Hall. “But we are expecting some multiple expansion, mainly from improving investor sentiment as these macro issues are dealt with.”

He anticipates that price/earnings multiples will expand to 16.5 times from 15.5 and, as a result, contribute about 6% to total returns. “As that happens,” he says, “there is potential for investors to swing out of bonds and into stocks. Equities should benefit.”

Hall and Robitaille, being bottom-up stock-pickers running a fund with 41 names, have reduced the BMO fund’s defensive exposure to real estate investment trusts (REITs), which now account for 17% of assets under management (AUM), vs 21% last summer. The fund also holds 22% of AUM in diversified financials, 30% in energy (split between 17% in exploration and production companies and 13% in infrastructure), 7% in telecoms and smaller weightings in sectors such as consumer discretionary and 4% in cash.

One favourite name on the energy side, and representative of the modest shift into cyclical companies, is Baytex Energy Corp., a heavy-oil producer based in Western Canada. Heavy oil trades at about US$58 a barrel, or US$37 below the benchmark, west Texas intermediate crude (US$96 a barrel).

“As we work through 2013, this price differential will start to narrow,” says Hall, adding that expanding pipeline capacity should be a factor in the narrowing differential. Although Hall has no stated target, he notes that Baytex stock, which is trading at about $46 a share, is yielding 5.7%.

Although reluctant to make annual market forecasts, Hovig Moushian, senior vice president with Toronto-based Mackenzie Financial Corp. and lead manager of Mackenzie Saxon Dividend Income Investor Series Fund, prefers to make longer-term predictions, which he then averages out.

“Seven [per cent] to 9% returns are reasonable, based on the fact that valuation levels are reasonable in the historical context, although slightly on inexpensive side,” says Moushian, adding that the total return should include a 4.25% dividend yield.

On the macroeconomic front, Moushian believes that even if China’s GDP growth slows to 7%-8%, that country “is still a significant contributor to the global economy. In recent months, we’ve seen China show signs of improvement. With the appointment of a new government last autumn, it will be a positive influence on global markets, and Canada.”

In a similar vein, Moushian is upbeat on the U.S. “From a directional standpoint, it will continue to show reasonably positive growth,” he says, noting the resurgence of the U.S. housing sector.

Although Moushian is cautious regarding Europe, he doesn’t believe its economy will worsen.

“All this put together,” he says, “provides a backdrop for our cautiously optimistic view. There is growth, but it’s not as strong as it was prior to the credit crisis. It will take a number of years to pull out of a significant global debt overhang.”

Running a fund with 54 names, Moushian has allocated about 29% of the Mackenzie fund’s AUM to financials (which includes REITs), 26% to energy, 10% to industrials, 9% to materials, smaller weightings to sectors such as telecommunications and 8% to cash.

A value-oriented stock-picker, Moushian has taken profits in the REITs sector and moved into cheaper stocks: “The underlying fundamentals for REITs are still reasonable, but valuations have reached as high as they have been in the past.” He notes that eligible stocks must be trading at a minimum of 15% discount to net asset value (NAV).

One recent acquisition by the Mackenzie fund is Barrick Gold Corp., the world’s largest gold producer. Barrick shares had been sold off last spring and its multiple had fallen below NAV, Moushian notes, compared with the historical average of two times: “There are changes taking place in the gold sector, with a greater focus on profitability and not just growth for the sake of growth. In an environment in which macro issues create outstanding risk, having some exposure to gold gives us a hedge against these events.” Barrick stock, which is trading at about $33 a share, has a dividend yield of 2.4%.

Another acquisition is SNC-Lavalin Group Inc., the global engineering firm that is mired in controversy relating to Libyan contracts. But Moushian argues that the market has discounted key components in the business, such as the concession business, which includes part ownership of Ontario’s Highway 407 toll road. SNC-Lavalin shares are trading at about $44.50 apiece, or about 11 times earnings and about 1.5 multiple points below its historical average. The dividend yield is 2%.

Investors should expect more of the same in 2013, says Rory Ronan, vice president, Trimark Investments, a unit of Toronto-based Invesco Canada Ltd., and lead manager of Trimark Canadian Plus Dividend Class Fund: “GDP growth will positive but sluggish. Economies are recovering, but it’s not a robust recovery. Markets will improve, too, although at a modest rate. I’m optimistic because there are still values out there. But you have to be selective. It’s difficult to find screaming bargains.”

From a macro perspective, Ronan says, Europe faces a difficult year, although the possibility of a eurozone breakup is now much lower: “[Europe is] suffering from high unemployment, too much debt, a stressed financial system and no growth. That’s a very difficult combination.”

However, like his peers, Ronan is encouraged by the economic rebound in China and the uptick in its industrial output. “Growth has decelerated, but it still looks pretty good,” says Ronan. Noting that infrastructure spending is likely to be more modest than in the past, he adds, “We’re dealing with the law of large numbers. It’s tough to keep on growing at a double-digit rate.”

From an equities perspective, Ronan argues that stocks are fairly valued: “But if you can find the right companies that you believe can grow at a modest rate and you like the business models, you can still get decent returns.”

A bottom-up portfolio manager, Ronan shares duties with Brian Tidd and Eric Menke.

About 70% of the Trimark fund’s AUM is in Canadian stocks, with 14% in the U.S., 13.6% in international stocks (half of the foreign currency exposure is hedged back into the loonie) and 2% in cash.

“The idea is to make a higher-quality and more diversified portfolio,” says Ronan, adding that the fund is run on a “total return” basis. “Our equities market is very concentrated. You can find names that are growing faster and trading at cheaper valuations outside of Canada.”

On a sectoral basis, about 23% of AUM is in financials, 19% is in energy and 16% is in consumer discretionary, with smaller holdings in materials and industrials.

One representative holding in the 48-name fund is Johnson & Johnson, a U.S.-based global firm that has shifted into medical devices and diagnostic tools, which account for about 40% of sales. “It has an extremely high-quality business, an AAA-rated balance sheet and raised its dividend every years for the past 50,” says Ronan, noting that the stock has a 3.4% dividend yield. “It has a good pharmaceuticals pipeline and should benefit from the acquisition of Synthes Inc.” (Acquired 18 months ago, Synthes is a leading provider of devices for the trauma market.) Johnson & Johnson stock is trading at about US$74.40 a share, or about 14 times earnings.

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