Financials Driven by Outside Forces

The Financial Sector is getting very attractive from both a fundamental and technical perspective. Definitely looking oversold and undervalued on the surface. Can you really rely on these indicators or is there more to it?

The financial sector has a market capitalization of $1.3 trillion dollars. This represents a little more than 25% of the TSX composite market capitalization of just shy of $4 trillion dollars. The financial sector includes the major commercial banks, diversified financial services and insurance companies. Some of the companies included in this index are AGF Management Ltd. (AGF.B), Bank of Montreal (BMO), Bank of Nova Scotia (BNS), CI Financial Corp. (CIX), Canadian Imperial Bank of Commerce (CM), Canadian Western Bank (CWB), Dundee Corporation (DC.A), and Great West Lifeco (GWO).

Since the high in May 2008, the index has fallen more than 50. On Friday Feb 20, 2009 the financial sector closed at $95.48. The high over the last year was $201.04 reached on May 2, 2008 while the low was $93.55 reached on Friday this year. Since September 2008, the financial sector has been trading in a clearly defined downward channel. From a technical standpoint there are no indicators as to where the bottom is for the financial sector. The highs and lows just keep getting lower.

Fundamentally, the P/E and the dividend yields are very attractive. The average P/E ratio is now 9.92 vs. 10.22 in November 2008 and the dividend yield is now 7.59 vs. 4.93 in November 2008. The only thing I would question is whether the P/E is valid given earnings revisions downward. This is something john Mauldin alludes to in his articles “Outside the Box”. Although it doesn’t appear that their payout ratios are high relative to cash flow, I would also question whether dividends will be cut based on how lofty they are.

In November, I pointed out that seasonally Banks tend to outperform at year-end. The year-end rally never came last year, so seasonality didn’t work and investors are no more desensitized to the bad news than they were last year. The bad news is more a result of worldwide problems in Banking than the Canadian Banks. John Morrissy from the Financial Post wrote on Wednesday, February 18, 2009, “Being the envy of the world--and most Canadians--did not stop Canadian bank shares from sliding to lows not seen in six years as the global financial crisis sent financial stocks reeling worldwide. Weakening corporate earnings and economic data, the stability of banking operations in Eastern Europe, fears of a General Motors bankruptcy filing and doubts about U. S. Treasury Secretary Timothy Geithner's bank rescue plan sent global stock markets sharply lower Tuesday, led by banking issues. The plunge in Canadian financial issues came despite a survey released Tuesday by PricewaterhouseCoopers showing 84 per cent of Canadians believe Canada has one of the strongest banking systems in the world, and praise paid at the recent G-7 meeting by world leaders who have had to rescue their own banks with billions of dollars in taxpayer bailouts.’ Canadians are confident in their banks, and they should be,’ said George Sheen, of the Canadian Financial Services practice at PwC. ‘They are well regulated, well capitalized and well run’”. Despite this, I would wait for at least some sign of technical support before jumping in too early because the financials are driven more by external forces at this time.

The Pulse of Healthcare

Healthcare has been getting healthier lately. Since the last time I wrote about healthcare the market capitalization has gone up from $12 billion to 16.6 billion which is still less than 1% of the TSX composite index. Some Canadian companies you may recognize that are included in the healthcare index are Biovail Corporation (BVF), Cardiome Pharma Corp (COM), CML Healthcare Income Fund (CLC.UN) and MDS Inc. (MDS).

The price of the healthcare index closed at $30.66 on Friday February 13, 2009. The high this last year was $41.83 in May 2008 and the low over this last year was $25.45 reached during Christmas 2008. From the bottom in December, healthcare has risen over 18%. It is technically bullish at this point with the lows and highs rising. The current price surpassed the 50-day moving average at the beginning of 2009 and is approaching the 200-day moving average.

From a fundamental perspective this sector is healthier. The average dividend yield is 5.83%, which is extremely attractive with bond yields being so low. With Obama planning to spend money on healthcare infrastructure, aging baby boomers and new developments in the medical field, I can’t help but think that healthcare is going to grow as an industry in Canada. There are a couple of challenges in Canada. First of all, the planned healthcare infrastructure spending is in the US and the Canadian market is very narrow in terms of choice compared to the US. The majority of the positive returns in Canada are a result of the increase in Biovail Corporation. The rest of the companies in the index haven’t contributed much recently. Make sure you take the pulse of the companies you include in your portfolio.

2009 Investment Outlook

If you missed the 'Friday Morning Coffee' (FMC) last week, I've prepared a
short summary below. I can also provide you with a copy of Gareth Watson's
presentation - 'Finding Direction in Unchartered Territory'. All you have
to do is ask.
There's Always Opportunity
While the economic reality is grim, it is what it is, and there are always
opportunities in the capital markets to either preserve capital, generate
income and even growth, but keep your expectations realistic. There are
investment strategies that work, regardless of whether-or-not the economy is
in a recession or the capital markets are in a bull/bear market. Some
strategies are short-term oriented while others are longer-term oriented.
The key is to have the right outlook which will lead to appropriate actions.
The actions taken should be relevant to your long-term objectives (i. e.
required return) and short-term constraints (i. e. risk tolerance, time
horizon, need for income, tax, legal, etc.). At present, we are seeing 3
knee-jerk reactions to the market: 1. Sell everything and move to cash; 2.
Keep buying on the dips; and 3. Do nothing. We'll address each one further
on and suggest some alternative strategies we think will work.
2008 in Review
The past 2 decades (the Greenspan era) have been a period of global trade
and easy money, leading to a global synchronized boom and culminating in a
global credit and housing bubble. While it is debatable whether-or-not
there was sufficient regulation, I would argue that there was a lack of
enforcement of the regulations that did exist. As a result, the whole thing
was one big ponzi scheme - All was well as long as there was someone to lend
to and someone to buy the debt.
The popping of both bubbles has resulted in a synchronized global recession
and a capital bear market. So much for decoupling and international
diversification. Equity markets were down anywhere from -35% in Canada to
-94% in Iceland. In the United States, 2.6 million jobs were lost and home
prices were down over 20%. To combat the problem, Central Banks, led by the
Federal Reserve, have been dropping rates and printing money but it's not
making it past the gate-keepers - the banks. They've finally become prudent
lenders. Regardless, consumers' net worth has been so decimated that
they've clamped down on spending. How do you replace consumer spending
which makes up the bulk of the economy?
Outlook for 2009
Governments will be the spender of last resort and budget deficits will be
with us for some time. The funny thing is that the deficits being talked about
still aren't large enough to get the job done. In John Mauldin's recent
e-letter, he provides some numbers which shed some light on the landscape
ahead. It's worth a read so, I've attached a link: http://www.investorsinsight.com/blogs/thoughts_from_the_frontline/archive/2009/02/06/further-thoughts-on-the-continuing-crisis.aspx

Bottom line, economic growth will be challenged for some time as will
corporate earnings. As a result, stock valuations in general are arguably
still too high. Deflation is still a risk and so interest rates will remain
low.

Investment Strategy
There will be no return on holding too much cash. Central banks will keep
rates low to discourage saving and encourage more borrowing, spending and
investing. Cash won't preserve capital either if you're an income investor,
as you won't earn enough to match your withdrawals. Buying on the dips
works great in a bull market but not so great in a bear market. You just
compound your losses.
Making money or preserving capital in 2009 will start with your asset mix.
In an economic recession with the end still out of sight, you want to be
underweight stocks and overweight bonds and cash. For now, focus on
defensive stocks that pay a sustainable dividend yield. For income
investors, dividend yields on stocks in general are higher than long-term
government bond yields. Volatility has come down but it is still
relatively high. There will be opportunities to trade, and there are some
industries that will benefit from all the government spending, such as
infrastructure. Speaking of alternative strategies, our best performing
investment in 2008 was managed futures, which was up over 20%.
Government bonds will offer safety of principle with income but little or no
growth. The real value is in corporate bonds, and if you're willing to move
out the risk curve, high yield bonds offer yields comparable to historical
long-term equity returns.
Policy makers might find that balance of fiscal and monetary policy that
wins back consumer, business and investor confidence. Then again, perhaps
we've caught a case of 'Japanese disease'. There won't be any easy returns
in 2009. Making money/preserving capital will require some work. Doing
nothing and hoping the markets come back is just wishful thinking. That
strategy has done nothing for the past 10 years. Even indexes rebalance
from time-to-time.
Gold
I must admit, I have always had a hard time understanding gold as an
investment. There are so many variables that impact the price of gold, most
of them intangible, it's hard to know which one will have the greatest
influence at any given time. If I had to pick a side of the fence to be on,
I would be on the bullish side, and mainly for insurance purposes. I came
across what I thought was a great article on gold in National Geographic.
Here is a link to the article:
http://ngm.nationalgeographic.com/2009/01/gold/larmer-text/1

Marc Faber
I'm excited to say that the world renowned economist, Marc Faber, PhD will
be presenting his 'Global Market and Economic Outlook' at the Fairmont Hotel
Vancouver on Friday, March 6. Mr. Faber is founder and CEO of Marc Faber
Limited, an investment advisor and broker/dealer. He is the editor and
publisher of 'The Gloom, Boom & Doom Report', which highlights unusual
investment opportunities. Previously Mr. Faber served as managing director
of Drexel Burnham Lambert (HK). He is a regular speaker at various
investment seminars and is well known for his contrarian investment
approach. Mr. Faber is a regular contributor to several leading
publications around the world and is the author of two best-selling books:
'The Great Money Illusion - The Confusion of the Confusions' and 'Tomorrow's
Gold'. He holds a PhD in economics from the University of Zurich. Mr.
Faber is also a longstanding member of the Barron's Round Table and
frequently appears on Bloomberg Television. For more information and to
purchase tickets click on the following link:
http://www.cfavancouver.com/default.aspx and check out the events calendar.

Using Some Discretion in Consumers

The Consumer discretionary sector makes up about 4% of the S&P/TSX Composite index. Some companies you may recognize are Astral Media Inc. (ACM.A), Groupe Aeroplan Inc. (AER), Cineplex Galaxy Income Fund (CGX.UN), Canadian Tire Corporation (CTC.A), Dorel Industries Inc. (DII.B), Forzani Group (FGL), Magna International Inc. (MG.A), Sears (SCC) and Tim Horton’s (THI).


Since the low point over the last year on November 20, 2008, the consumer discretionary sector has risen about 6%. The S&P/TSX Composite has risen 16.6% in comparison. Although we are seeing rising bottoms, the current price is below the 50 day moving average. At the end of December there was brief rally where it crossed the 50 day moving average. However, since the beginning of the year, the trend has been down and been bouncing against resistance at the 50 day line. Technically, not a bullish sign and no sign of improvement.

Fundamentally, the recession is not being kind to consumers and things will likely continue to worsen. On Friday the US job loss report was worse than expected. Since the recession began in the US they estimate 3.6 million jobs lost. This is giving Obama some ammo to get his stimulus package through the Senate. In the Globe and Mail this weekend in an article titled The Close: Jobs meets Stimulus, it was written, “If investors were betting on Friday that the dismal U.S. jobs report for January would turn up the heat on the political necessity for a massive stimulus plan, they were right: President Barack Obama immediately used the 3.6 million job losses since the recession began to push for the U.S. Senate to approve his $900-billion (U.S.) stimulus plan without delay.” Since people are not spending like they used to, it is going to hit consumer discretionary stocks harder than most. There are some trends worth noting in a recession that will benefit some stocks in consumer discretionary sector. For example people substitute expensive goods for less expensive goods. Consider this when picking your stocks in your portfolio from the consumer discretionary sector.

Are Industrials stalling out?

On Friday Jan 30, 2009 the Industrials index closed at $71.73. The high over the last year was $121.33, which occurred in June and the low was $64.51 in November. Since the low, the Industrials index has risen 9.5%, which is in line with the broader index in Canada and the US. Until the beginning of the year, the Industrial index was pretty bullish with the lows getting higher and the highs getting higher. The channel moving from left to right in an upward direction. However, since the beginning of the year this sector has fallen about 8.5%.

The Industrials sector has a market capitalization of about 260 billion. It represents about 5% of the broader Canadian market S&P/TSX Composite. Some of the companies that are included in the Industrials sector are BFI Canada (BFC), Bombardier Inc. (BBD.B), CAE Inc. (CAE), Canadian National Railway (CNR), Canadian Pacific (CP), Jazz Air Income Fund (JAZ.UN), Ritchie Bros. Auctioneers Inc. (RBA), Russell Metals (RUS), SNC-Lavelin (SNC), Stantec (STN) and Westjet (WJA).

The average dividend yield is 3.45% and the average P/E is 10 for the Industrial index. This suggests that the index is not overvalued relative to the S&P/ TSX Composite. So is this a good time to invest in industrial stocks in Canada? The industrial sector is well represented by infrastructure plays so it should benefit from infrastructure spending in both Canada and the US. They still face some challenges. In Rob Carrick’s Portfolio Strategy column in this weekend’s Globe & Mail, avoiding potholes chasing infrastructure bucks, he argues “some infrastructure stocks have already risen in anticipation of the infrastructure boom, though in Canada some opportunities still remain.” In the US some of the infrastructure stocks have already risen 50%. Furthermore, individual investors are at a disadvantage to large pensions and institutional investors because larger investors can invest directly in projects such as bridges and toll booths as opposed to through the companies. This gives them income and bond like qualities vs. just another diversification play in stocks. Another challenge to Canadian infrastructure companies is if the US decides to become more of a protectionist in its practices. Lastly, these companies are not impervious to the recession and they have possibly risen in anticipation of the proposed stimulus in Canada and the US. It will likely take some time before these companies experience the benefits of rising revenues from contracts for infrastructure improvements.

Since the low in November, we have seen more positive technical signals, however it is in line with the broader market moves and the trend has turned more bearish over the last 2 weeks. Fundamentally, the industrial sector is not over valued, with the exception of a few stocks. Despite the stall in the short term, the longer term industrial sector stocks will benefit from infrastructure spending. Now would be a reasonable time to add these stocks to your portfolio. Invest in industrial stocks that benefit from infrastructure spending in healthcare, transportation, logistics and technology.

Materials make a double-edged sword

So if we’re in the midst of a global recession and there is all this talk of less demand for materials worldwide, why has the materials sector rose so much in the last 2 months?

The total market value of the materials index in Canada is a little more than $1.6 trillion. This currently represents about 25% of the TSX Composite index. Some of the companies that make up the materials index include Agnico-Eagle Mines (AEM), Agrium (AGU), Barrick Gold (ABX), Canfor Corp (CFP), Goldcorp (G), Harry Winston Diamond (HW), Potash (POT), Methanex (MX), Silver Wheaton (SLW), Teck Caminco (TCK.B) and Labrador Iron ore Fund (LIF.un)

The S&P/TSX materials index closed on Friday January 23, 2009 at $253.34. The high over the last year was $426.23 and the low was $157.13. Since the low on October 24, 2008 the materials index has rallied over 40%. In comparison, the S&P/TSX composite in Canada is down -7% and the S&P 500 is down -5%.

Technically, the materials sector has been bullish. Since the low on October 24, 2008 a positive rising channel has formed suggesting strong momentum with the lows and highs rising. In addition, on Dec 8, 2008 the current price crossed the 50day moving average.

Last month I wrote that Gold is starting to shine and to watch it because it was exhibiting both fundamental and technically positive indicators. Barrick just became the largest company in terms of market capitalization on the S&P/TSX over taking Royal Bank of Canada and EnCana Corp. Since the October 24, 2008 low, the Gold sector is up over 80%. That goes along way to explaining why materials have been up over 40%. Also, it tells us something about the rest of the materials sector if gold companies represent a large share of the index.

The rest of the materials sector isn’t shining like gold. That doesn’t mean it won’t shine. One thing in the Materials sectors favour is the seasonal effect which tends to take hold from now until May where materials tend to rise. The other positive is the induction of Barrack Obama and the hope that the US economic stimulus will offset earnings concerns moving forward. The barriers of a global recession and continued earnings reports that are worsening still stand. Global demand has put a real damper on the demand for materials, with the exception of gold lately. The one thing that drives it up is caused by the one thing that drives the rest of the sector down. It appears to be a double-edged sword for materials, so choose your weapon carefully.