Posted: Wednesday, March 14, 2018 - 16:15 EDT
- Despite the recent spike in volatility and share price correction, Foresters Asset Management ("FAM") remains bullish, based on strong global economic fundamentals and increased corporate earnings growth for stocks in North America.
- imaxx Mutual Funds, where possible, took advantage of U.S. regulatory and tax changes by increasing U.S. exposure in 2017, with partial currency hedging applied for Canadian-centric mandates.
- With a typical 2% weighting to each holding, smaller positions are carefully scrutinized for elimination or higher level of conviction. Portfolios are more focused, to exploit FAM's research capabilities and providing better opportunity for long term outperformance.
- Select IPOs, Canadian firms with global exposure, and domestically-focused U.S. names are being added to the portfolios to take advantage of the current climate.
Until late January, U.S. equity markets were running 'hot'. As recently witnessed, considerable optimism among investors has been replaced by concern given the spike in volatility and the sharp correction in share prices. Nevertheless, we remain bullish, based on strong global economic fundamentals and increased corporate earnings growth.
The implications of U.S. tax reform are very positive in the medium term for the U.S. market and the economy. With incentives for write-offs (i.e. accelerated depreciation), corporations are likely to significantly increase CAPEX over the next couple of years: businesses are going to spend and this, coupled with consumer spending, will be a driver for future growth. Tax reform and de-regulation will also give a boost to companies' bottom lines, which should provide a tailwind for equity prices. Notably, we have had an aggressive call for 16% U.S. corporate earnings growth this year. This is now a consensus position in the market. In a sense, these medium term positives are borrowing from the future, as over the longer term, the resulting increase in U.S. government debt, together with rising interest rates, may create headwinds down the road.
Here in Canada, the S&P TSX Index ("TSX") remains in negative territory for the year. The Canadian economy, as it has been for a while now, continues to be faced with a few major risks: 1) high levels of household debt/the potential for a house price correction, 2) the risks associated with NAFTA negotiations and other trade issues, and 3) the direction of oil prices. As it relates to oil, we may have seen near-term highs and will be carefully watching the supply-side response. Despite all these risks to the economy, we would point out that from a valuation perspective, the TSX actually compares favourably with the S&P 500 and we are now equally bullish on Canadian and U.S. stocks, allowing country weights to be driven by bottom-up stock selection.
Bonds have sold off sharply so far in 2018, due to the spike in rates: the U.S. 10-year started the year under 2.50%, now sits at 2.89% and could easily hit 3.00%. The Canadian 10-year has followed suit, and in Europe, the German bund now has a positive yield for the first time in a long while. Fixed income markets are coming to terms with a few factors that are bearish for bonds: U.S. inflation is starting to manifest itself, the Fed is beginning its slow unwinding of QE, and the large deficit this year due to tax cuts will result in a large amount of Treasury supply which will need to be absorbed.
Turning to currencies, 2017 was the worst year for the U.S. dollar in a decade vis-à-vis the Canadian dollar and globally. This weakness is continuing for a few reasons. First, monetary tightening outside of the U.S. will likely happen quicker than markets had priced in. Second, huge U.S. fiscal deficits will materially raise debt servicing costs. And finally, demand for U.S. bonds is clearly weakening, as the Fed is no longer buying bonds and China is also questioning its support for U.S. debt.
Current imaxx Portfolio Positioning
- Across the imaxx equity Funds, including imaxx Canadian Fixed Pay Fund, we increased our U.S. exposure last year. In Fixed Pay, we have the ability to go up to 30%. We're currently around 17-18%. We consider 15% U.S. exposure to be relatively neutral and have been applying an incremental currency hedge above that level.
- The imaxx Equity Growth Fund has the ability to go to 50% U.S. exposure. We're currently around 30%. We will apply a hedge above 20%. We don't apply currency hedges to the imaxx Global Equity Growth Fund.
- We're looking at adding some international sleeves to the Fixed Pay Fund and other domestic imaxx Funds. Emerging markets have helped the imaxx Global Equity Growth Fund since last summer, and we may look to add to this position. Emerging markets are benefiting from synchronized global growth and the weaker U.S. dollar.
- We are targeting a focused 50 holdings for both U.S. & Canadian exposure. We've been doing a sector by sector analysis and trimming names. REITS is a good example of where we've consolidated positions. Our neutral holdings are typically in the 2% range, so we've been scrutinizing smaller positions. Based on extensive discussions, we've been adding to or disposing of these names.
- We've been selectively adding and monitoring both mid and small-cap stocks. That said, microcaps have been underperforming as of late and liquidity is a risk we factor in to our investment decisions.
- Mining and minerals stocks can represent opportunities to enhance the diversification of even our core income and capital preservation style portfolios. Selecting stocks in this sector that have the higher ESG ratings is consistent with emphasizing higher quality companies and more predictable cash flows. FAM's equity portfolios have modest exposure to copper, to benefit from global growth and electric vehicle production. Where appropriate, a small exposure to cobalt has also been added to portfolios. Cobalt, a critical component to the production of lithium ion batteries, is a byproduct of mining and most reserves are located in precarious jurisdictions.
- Current Asset Mix – imaxx equity and balanced funds.
|March 1st, 2018||Canadian Equities||Canadian Bonds||U.S. Equities||Global Equities||Cash||Total|
|imaxx Canadian Fixed Pay Fund||60.0%||19.0%||17.0%||0.0%||4.0%||100.0%|
|imaxx Equity Growth Fund||67.0%||0.0%||29.0%||0.0%||4.0%||100.0%|
|imaxx Canadian Dividend Plus Fund||74.0%||0.0%||19.0%||0.0%||7.0%||100.0%|
|imaxx Global Equity Growth Fund||4.0%||0.0%||55.0%||37.0%||4.0%||100.0%|
Recent Trades That Are Reflected Across Multiple imaxx Mandates
- Alimentation Couche-Tard, a convenience and gas store company, has been increased in the portfolios. The stock has been under pressure, given longer-term concerns with regards to the sustainability of gas stations, with the advent and growth of electric and hybrid vehicles. These concerns are well-reflected in the stock price. The business mix is 15% Canadian, 65% U.S., and 20% European. We believe it is a good organization in a good competitive position – in Norway the firm is already experimenting with electric charging stations at its gas stores.
- Sun Life: The insurance company should benefit from rising rates, especially given that 50% of its earnings are from the U.S. FAM already owns Manulife but wanted to add Sun Life due to its good growth outlook, lower write-down risk, and simpler business model.
- Key Corp. is a U.S. financials holding company. It's a domestic player that operates in the U.S. Midwest and will benefit from deregulation, economic growth and tax reforms. It's attractive from a valuation perspective, trading at a discount to peers (13x earnings compared to 15x).
- Fastenal is a U.S. industrial distributor, poised to benefit from infrastructure spending, CAPEX and tax reform. Industrials have been in an industry recession and secular decline, with digital disruptors moving margins lower. However, these concerns have been built into valuations, and now present a good entry point. We also believe this company has good barriers to entry from new entrants.
- Pinnacle is a recent IPO and Canadian biomass stock that recycles and produces wood pellets that provide electricity in Europe and Japan. The stock is benefiting from the demand for renewable energy. FAM has done extensive fundamental analysis and has met with management. The initial valuation didn't pass our valuation screen, and we initially stuck to our pricing discipline and provided extensive feedback to the company. We were offered a price that was attractive and participated in the company's recent and successful IPO. FAM has the advantage of being a nimble and smaller fund house, whereas larger institutions can't get positions big enough in this type of small company to benefit their portfolios.
- FAM exited its Wells Fargo position across a number of mandates. The stock is mired in controversy and fares poorly on our ESG screens.