Morningstar convened a trio of prominent portfolio managers for a timely discussion of the current volatility in the Canadian equity market and how it's affecting their outlook for various sectors and specific companies. Our panellists:
Michael O'Brien, managing director and head of the core Canadian- equity team at TD Asset Management Inc. His responsibilities include serving as lead manager of TD Canadian Equity, TD Canadian Blue Chip Equity and TD Balanced Income.
Mark Thomson, managing director and head of research at Beutel, Goodman & Co. Ltd. Thomson and his team are responsible for a range of mandates including Beutel Goodman Canadian Equity, Beutel Goodman Canadian Dividend and Beutel Goodman Balanced.
Daniel Bubis, president and CEO of Winnipeg-based Tetrem Capital Management Ltd. Bubis manages a range of mutual funds for CI Investments Inc., including CI Canadian Investment and CI Canadian Investment Corporate Class.
Morningstar columnist Sonita Horvitch moderated the roundtable. Her three-part series continues on Wednesday and Friday.
Q: After hitting new highs in early September, the Canadian equity market, as measured by the S&P/TSX Composite Index, corrected more than 10% in mid-October. It has been volatile since. Do you see this correction as a warning or an opportunity?
O'Brien: It's a bit of both. Whenever we go through these events, it's important to re-evaluate your investment framework. If you consider that this is still valid, then you start thinking of the correction as more as an opportunity. It is a warning in that even though the financial crisis is in the rear-view mirror, there is still a lot of unfinished business. The sudden dip in the growth trajectories out of Europe, particularly in Germany, has unnerved the market and is a reminder of this. We are probably going to continue to experience the slow stop-and-start economic recovery that we have had in the last four or five years, with one piece looking like it is coming together and then another starts to slow down. All the while, it is two steps forward and one step back. In all, it has been a difficult year so far for stocks, though it looked great earlier in the year.
Thomson: The correction is primarily a warning against complacency. We had an extended run-up in the market over some 14 months and risks built up. Investors did not recognize this and those who abandoned their discipline have taken a hit. Liquidity is the fuel that runs markets. We are in a positive environment and have been for five years. This should probably continue for an extended period of time. I see weak economic growth as a positive for stocks for the long term. Liquidity has to go somewhere. U.S. Federal Reserve Board tapering is irrelevant to me, as we are awash in liquidity. The bond market has been a huge beneficiary of this. Relative to bonds, stocks are attractive.
| Index | YTD | 1 year | 3 year | 5 year | 10 year | |
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| S&P/TSX Composite | 8.9 | 12.6 | 9.9 | 8.0 | 8.0 | |
| S&P 500 (C$) | 14.2 | 30.5 | 26.1 | 16.7 | 6.8 | |
| MSCI World (C$) | 9.7 | 22.6 | 21.4 | 12.4 | 6.4 | |
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| Data as of Nov. 23 Source: Morningstar |
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Bubis: The stock-market correction and the rally in the bond market made the relative valuation in favour of stocks even more attractive. The stock-market correction is markets doing what markets do. They don't go up in a straight line. Volatility has spiked up here. It's not called a fear or anxiety measure for nothing. This correction has created an opportunity to reset valuations. In some areas, particularly in some of the more cyclical areas, it has reset valuations quite attractively from my perspective. An example is the energy sector. The oil price has been hit by a confluence of factors. A plus is that the drop in oil prices will provide a substantial boost to the German economy, which is key to the European economy.
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| Daniel Bubis | |
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The financial crisis in 2008 into 2009 could be viewed as an earthquake. You need to expect aftershocks and these, as measured in a number of different ways, have been coming. But they have been getting progressively smaller and more spread out. This correction was one of them. We hadn't had one since 2011-2012, when the world was worried about Europe falling apart. This September, the concern was more about interest rates rising and inflation coming back. But in two to three weeks, the concern switched back to the downside risk of a deflation. The aftershocks have been from this tug of war between inflation and deflation concerns.
Q: The oil price has dropped sharply. What does this mean for the Canadian energy industry and, in particular, the oil sands?
O'Brien: I would not be racing to shut down Fort McMurray any time soon. At a recent internal meeting, we discussed whether something fundamental in the oil market had broken to cause the weakness in the price. The consensus was that it was not a fundamental break, but more of a temporary situation. There was less agreement on how long the oil market can stay sloppy. Will the Saudis solve this all on Nov. 27 by cutting production at an OPEC meeting? Or is it going to take three months, six months? Our view was that from a longer-term perspective, the oil price is unlikely to stay at these levels.
How does the current price environment affect the Canadian oil sands? Take, for example, Cenovus Energy Inc. CVE with its oil-sands project Foster Creek or Suncor Energy Inc. SU with its oil-sands mines or Canadian Natural Resources Ltd. CNQ with its Horizon oil-sands project. These projects have already been built, the costs are sunk and the companies are not going to shut them down. This type of oil price might delay future expansion, if the oil patch comes to view the current oil price as the new norm.
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| Michael O'Brien and Mark Thomson | |
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Q: We should also discuss base metals and gold stocks.
Bubis: Times are tough for these areas. In the case of gold stocks, I think that there are better opportunities elsewhere. I have no strong opinion of where bullion is going.
Thomson: A call on the bullion is not a call on the stocks. The commodity can do well and the stocks don't necessarily follow. Gold stocks account for 8% of the S&P/TSX Composite Index and for less than 2% of the index's earnings. The valuations are stretched.
O'Brien: To offer a positive comment, relative to how these companies were run when gold prices were soaring, at least now they are acting more like real businesses with management exercising greater discipline.
Bubis: It will be interesting to see what happens to management discipline if the gold price soars again.
Q: Base-metal stocks?
Thomson: There is a very restricted menu when it comes to Canadian base-metal stocks. Most are operating in jurisdictions that I am uncomfortable with. They're not great businesses either.
Q: During the correction in the S&P/TSX Composite Index, how did energy and materials fare?
O'Brien: The market peaked on Sept. 3, and thereafter the sectors that were hit hardest in the mid-October correction were energy and materials. The consumer-staples stocks held-up well as did health care, telecom and utilities, your classic defensive sectors. Financials took a bit of a hit, more the insurers than the banks. Real estate investment trusts held in well.
Bubis: Anything viewed as more of a bond proxy held up well in the correction.
Q: Can we summarize?
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| Mark Thomson | |
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Bubis: This correction resets the opportunity basket from a bottom-up perspective. As Mike noted, looking at sectors, it has not been even selling across the board.
O'Brien: We've been building a shopping list, looking for opportunities to buy more of the stocks that we already liked and which became better value with the correction.
Thomson: We also had a couple of buy programs for existing names in place and the stocks became more attractive than before.
Q: What returns do you expect from equities going forward?
O'Brien: In the last five years, we've been consolidating the economic recovery after the global financial crisis. Because the equity markets fell so low in 2008 and into 2009, there was a lot of make-up room and we generated these strong double-digit returns a year for the better part of five years.
Bubis: Now it's normalizing.
O'Brien: Yes. Valuations on stocks are all right. They're not necessarily a headwind or a tailwind. But we're not at nine times earnings per share anymore. Going forward, we're looking at more modest returns.
Bubis: It's back to stocks being attractive relative to 2% bonds.
Photos: paullawrencephotography.com
