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TriDelta Investment Counsel – Q1 2015 investment review

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Executive Summary – Good times in the stock markets may last a while

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Another quarter rolls by, and overall, it was another quarter of very solid returns for our clients. Can the good times for investment markets continue?
 
The pessimists of this world say “this has got to end soon”. The optimists say “maybe this is the new reality”. Our general view is that both are wrong. History teaches us that there are few to no “new realities” – eventually it repeats itself. At the same time, should we expect strong stock markets to end in the near future? We don’t think so.
 
Here are three reasons:

  1. Valuations are not unreasonable. The chart below is from JP Morgan based on the US S&P 500 index as of March 31, 2015. It shows current Price/Earnings ratios today as a percentage of the 20 year average of Price/Earnings ratios – so 100% would suggest things are at the 20 year average, 110% would be 10% over the average and 90% would be 10% under the average.
     

      Value Blend Growth
    Large 116.4% 104.3% 91.7%
    Mid 124.4% 118.1% 98.5%
    Small 114.3% 107.1% 97.4%

    This chart shows that while the overall market has a higher P/E ratio than the 20 year average, the higher valuation is skewed toward Value stocks, and in fact Growth stocks currently have valuations that are UNDER the 20 year average – especially among large companies. While this can provide some guidance for which types of names to buy in the market, it would suggest that on a purely valuation basis, despite several years of good markets, corporate earnings have mostly kept up. On its own, valuations would not drive us to lower our stock weightings.

  2. Rising interest rates should actually help stock markets. Over the past 52 years, a study of weekly stock market returns (S&P500) and 10 Year US Treasury yields, showed that when the Treasury yield was under 5%, there was a positive correlation between rising rates and stock market returns. Once the 10 year yields were over 5%, it became a negative correlation. Today’s 10 year US Treasury Yield stands at 1.9%.
     
    Based on this data, the next 3% of interest rate increases will actually correlate to a rising stock market. It is our view that this process will take a few years. When you consider that German 10 year bonds are trading at 0.15%, you realize that there still is room for US 10 year bond rates to decline from here. Even if there is no decline, at least rising rates will be constrained within this type of Global rate environment.
     
    There are a couple of reasons why stock markets would rise as interest rates climb. The first is that rising interest rates are often connected to growth in an economy, and if that growth is coupled with cheap money in the form of interest rates under 5%, it tends to be a good environment for stocks.
     
    The other reason might be that rising interest rates are not good for bond returns, and if that is coupled with bond yields under 5%, it tends to be a weak incentive to invest in bonds. If money doesn’t want to be in bonds, it tends to create inflows to stocks. If bond yields were 10%, but there were some capital losses, most people would still be comfortable holding bonds.
  3. Retirees are forced to invest in stocks at these interest rates. Today, a 65 year old couple has a 47% chance of at least one of them living to age 90. Essentially this means that 65 year olds need their money to last at least 25 more years – probably 30 years to be ‘safe’.
     
    If you have $1 million and GICs pay 8%, then they can spin off $80,000 a year and even with high inflation, you are in good shape.
     
    Today, retirees can invest it in GICs and it will spin off $18,000 if they are lucky. This means they would have to drawn down their savings each year to make ends meet. Can retirees afford to do that for 30 years?
     
    As a result, those with the largest portfolios (mostly those aged 65+), who used to have a much lower portion invested in stock markets, will need to be meaningfully invested in stocks (or high yield bonds) at least until they can get 4% or 5% on their GICs. That will take a while.

In the short term anything can happen. We fully expect there to be a 5% to 10% downturn at some point in 2015 because that happens most years. However, overall, we think that valuations, interest rates and demographics remain supportive for stock markets.

The Quarter that Was

The TSX had an OK start to the year, with a 1.8% return over the quarter. Of course, energy was down another 1.9% and financials were down 1.1%, but most of the smaller sectors helped to keep returns above water.
 
Declining crude prices continued to put pressure on energy stocks, but technically stocks are behaving well having put in what may be their low in December with higher highs and higher lows since then.
 
TSX earnings seem to have stabilized. Trailing 12 month corporate earnings numbers continue to fall, but the forward 12 month estimates have started moving up.
 
The Canadian financials have recovered from a very weak January where the index was down more than 8% on fears of a weaker Canadian economy (mainly Western Canada) and housing market.

The US S&P 500 was up just 0.4% in the quarter. But currencies added 9.1% for Canadian investors!!
In the US the best performing sector was Health Care, up 6.1%. The worst sector was Utilities, down 6.0%.
 
There was a very weak start in U.S. stocks on lackluster Q4 earnings where concerns over a strong dollar and slowing global growth were a recurring theme. This seems to have recovered somewhat.
Consumer sentiment has held up with the Consumer Confidence Index hitting a 7 ½ year high in January in the U.S.
 
Economic numbers were mixed with decent housing starts but weaker consumer spending, which may be somewhat related to the cold winter and heavy snowfall in the Northeast.
Earnings are stable as trailing numbers and forward estimates continue to rise.
 
With continuing drops in interest rates, bonds had a very good quarter, up 4.1%.
Global Central Bank policies continue to be the focus of headlines.
In Europe the ECB maintained a bias towards lowering rates and quantitative easing (governments buying their own bonds to keep rates low) in an attempt to keep their currency low and to stimulate growth.
 
In Canada, the Bank of Canada surprised with a 25 basis point rate cut on January 21st when no policy move was expected. The overriding concern is how Canada and its economy will deal with a US$50 a barrel environment for oil.

In the US, the Federal Reserve was quick to change its tone towards keeping rates steady instead of an expected increase. This was driven by deflationary concerns that came about from lower energy prices coupled with a strong US dollar.

How did TriDelta Do?

First quarter 2015 was very positive for TriDelta clients. Depending on risk tolerance/asset mix, most clients were up between 3% and 5.5% for the quarter, with the high growth oriented clients doing better, and the most conservative returning at the lower end of that range.
 
The TriDelta High Income Balanced Fund – was up 7.1% on the quarter.
 
The fund – which currently delivers a yield of over 7% – aims to provide income from diversified sources that include Global Bond yields, options, dividends and leverage. The fund is essentially a Global Balanced fund but we utilize a wide number of investment tools to achieve higher returns.
 
Some good regulatory news came through this quarter, which will allow all TriDelta clients the opportunity to own the fund (as opposed to only Accredited investors). This will come into effect in May and will allow for new investments as of the end of May.
 
Given a TSX return of 1.8%, we were very pleased with the results overall.
 
Our two biggest drivers for outperformance were:

  1. Between 30% and 40% of our stock weighting has been outside of Canada (U.S., Europe and Emerging Markets). Because of US currency gains and strong stock markets in Europe and Asia, these parts of the portfolio have done better than Canadian stock numbers.
  2. TriDelta has been significantly underweight energy, particularly with our Pension clients. In July we sold one of our two pure Energy stocks (Suncor), and bought the Pharmacy, Jean Coutu. To date, this trade has been a 40% swing to the positive. While we may find the value in Energy compelling at some point, for the most part, we find that our clients don’t want the volatility that comes with a high energy weighting, and we can find other industries and names that are more appropriate alternatives.

What worked well in Q1?

In our equity portfolios we continued to see the US$ working in our benefit. The leading performers had a US and technology slant with Avago Technologies and Apple leading the way.
 
Best Equity Performers – Core – Avago Technologies +31.0%, Fairfax Financial +18.9%, Moody’s +18.9%
 
Best Equity Performers – Pension – Apple + 23.7%, GlaxoSmithKline +22.1%, General Mills +16.9%
 
In the Bond and Preferred space, lower interest rates produced some nice winners.
 
Highway 407 6.47%, July 27,2029 bond was up 9.0% on the quarter as it benefits from a high yield and declining long term rates.
 
Brookfield Asset Series 18 preferred share was up 8.1% on the quarter.

What did not work well in Q1?

Before we talk details on what didn’t work, we have been asked by some industry colleagues “Why do you show people what didn’t work?” Our answer to that is simple:

  1. Transparency with clients is important
  2. It always helps an organization to review what isn’t going well
  3. It reminds everyone that even strong investment management returns include weak performers in a portfolio
  4. We like to be a bit different from the rest of the industry

This quarter, after the currency effect, Canadian stocks lagged the US (and most other world markets). Energy, Canadian Financials, and any business that seemed closely tied to Western Canada suffered.
 
Our weakest performing stocks were as follows:
 
Core – Michael Kors -4.3%, TransCanadaPipeline -4.3%, TD Bank -1.5%
 
Pension – Home Capital -10.9, ConocoPhillips -7.3%*, Corus Entertainment -6.5%
 
In the Core/Growth model, we still own all 3 of the weaker performers from this quarter. While we continually review our holdings for signs of problems, for now we are planning to continue to hold these names (always subject to change).
 
In the Pension model, we only continue to hold Home Capital. Its decline was largely based on fears of real estate declines and risk among non ‘A’ level borrowers. Home Capital is such a strongly managed company that has been able to work through much worse times than today, and we continue to like the name.
 
ConocoPhillips was actually sold on January 8th so we didn’t really participate in the losses for the quarter. Corus was sold (just in time) at roughly $22 on March 13th. It has since dropped 20%!
 
In the Preferred Share space, all rate reset preferreds (those that have dividends that will reset to a rate that is tied to the Government of Canada 5 year yield) had a very poor quarter. While we don’t see much in the way of increased interest rates in the very near future, we do believe that this sector of the market has been overly beaten up and is undervalued – and we may add to some beaten up names.
 
Cannaccord Series A 5.5% Variable was down 24.3% in the quarter, and represented our worst holding.
 
Its 5.5% dividend won’t reset until September 30, 2016, and at that time will reset at 3.12% above the 5 year Government of Canada yield, which today stands at just 0.6%, but could certainly rise in the next 18 months.

Dividend Changes in Our Portfolios

We continue to be pleased with a steady flow of dividend increases and no dividend cuts in our investment portfolios.
 
This quarter in our income oriented portfolios the top four dividend increases were:

Company Name % Dividend Increase Company Name % Dividend Increase
Canadian Utilities +10.3% Home Capital +10.0%
Potash +8.6% General Mills +7.3%

In our Growth portfolios, the overall dividend yields tend to be lower, but some of the trends of dividend increases have been very solid. Below are the four biggest percentage increases in the quarter:

Company Name % Dividend Increase Company Name % Dividend Increase
Sherwin-Williams +21.8% Moody’s +21.4%
3M +19.9% Magna +15.8%

What do we see in the Quarter Ahead

  • More volatility by sector – you won’t see as much of the overall market moving higher or lower as much as a few sectors pushing much higher or lower.
  • Interest rates remaining mostly stable to lower in Canada and Europe. The United States won’t likely see the Fed raising rates this quarter, but we still expect to see it this year.
  • Oil looks to have found a base from a technical perspective and may allow for some trading gains, but we can’t see any big move forward as long as oil inventories keep pushing new heights. We believe it will be a lot of ‘one step forward, one step back’.
  • Canadian dollar remains under some pressure, but seems to have found some support in the 78 to 80 cent range unless Oil makes a major move from here in either direction or there is another Bank of Canada rate cut.

Summary

TriDelta Financial is celebrating its 10th Anniversary this month and we are very thankful to our clients for helping us to reach this milestone.
 
We are planning to do a couple of special client thank you events in the coming year to celebrate – details to follow.
 
Enjoy the soon to be realized Spring!!

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

2015 Financial Forecast & Review of Solid 2014 Predictions

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TriDelta Financial forecasts good but weaker returns in 2015 than 2014
 
Accountability – someone recently told me that this word seemed to be disappearing in society. It made me think how predictions are easy to make, especially if there was no accountability for how they did.
 
At TriDelta Financial – we believe in being accountable to our clients. We are even accountable for our predictions – which will not always be correct.
 
Here is what we said last year:
https://www.tridelta.ca/tag/2014-forecast/
 

  • US Equities over Canadian Equities – both for Total Return and also because of Currency.
  • We preferred Industrials and Technology and mentioned 3 stocks that we liked for 2014:
    • CISCO – Total return in Canadian dollars for 2014 is 41.7%
    • Goodyear Tire – Total return in Canadian dollars for 2014 is 32.0%
    • Magna – Total return in Canadian dollars for 2014 is 48.4%
  • Equities over Bonds – We were correct in not seeing interest rate increases in 2014 and that the Prime Rate would remain unchanged (this was different than most opinions of rising rates). However, we did not see the meaningful declines in long term yields that took place during the year, and it turned out that Bond returns (while not as strong as stocks), were better in 2014 than we thought.
  • Canadian dollar would continue to decline. We correctly predicted that the Canadian dollar would fall from 94 cents, but thought it would end the year at 90 cents. It turned out that the decline would be greater than we predicted.

Overall, our 2014 Financial Forecast was mostly correct. In fact, these beliefs helped us to deliver a return of over 15% in 2014 on our one fund, the TriDelta High Income Balanced Fund.

 
Now for our 2015 Financial Forecast

TriDelta Financial 2015 Year End Predictions
TSX Total Return 5% A little lower than 2014
S&P 500 Total Return (in US$) 8% A little lower than 2014
DEX Canadian Bond Index Total Return 2.25% Lower than 2014
Canadian Bank Prime Rate 3.5% 50bps higher in 2nd half
10 Year Gov’t of Canada Bond Yield 2.25% to 2.50% Moderate increase
Crude Oil (WTI) $70.00 Decent increase
Canadian Dollar vs. US$ at year end $0.84 Small decline

US Equities over Canadian Equities – Again we expect the US equity market to outperform Canada. While we do not expect a repeat of the outsized U.S. returns that have occurred over the last two years, we do expect US equities to produce decent single digit returns (7-9%).  Last year we had thought that returns in the U.S. would be mainly based on earnings growth as earnings multiples seemed to be at a reasonable level. Analysts were expecting 10% growth in earnings and as it turns out earnings grew about 7% despite currency headwinds and continued global strife.   The multiple also expanded a bit to deliver the roughly 13% US$ return. The major concern in Canada revolves around oil. If oil decides to hang around the $50 – $60 level it looks like earnings estimates could come down and the expectation of 16% earnings growth that is currently in the market could easily fall.

Canadian Equities – As noted above we still expect positive returns for the TSX in 2015, but oil and the trickledown effect of its precipitous decline especially in western provinces is the big question mark.   Valuations for many of the dividend payers (especially the banks) continue to remain reasonable especially in a low interest rate environment and could have some multiple growth and earnings growth to pick up the slack from a poor energy market.. 

Sectors to Outperform –Two stocks with some cyclical US exposure we think will do well next year are 3M and Allegion as the US economy continues to gain traction. Health Care stocks could be another solid performer next year as the fears around Obama Care subside, mergers continue and demographics are favourable. Another name that we see both strong earnings growth and dividend growth in 2015 would be Apple.

Oil  – It would be great to say that we see a big rebound this year but we think we are going to stay at reasonably depressed levels for some time. The question is whether approximately $50 oil is a new price driven by supply and demand, or the result of more complicated components of the market. While we don’t see a bounce back to $100 oil, we still believe that the pendulum has swung too hard in one direction, and we will see some bounce back from here. However, the bounce back won’t be as large as many predict. Hopefully we have seen the worst for oil and we will be able to capitalize on a couple of tradable rallies but we don’t think we will have many major long term holdings in the sector this year. We will also be looking at related industries such as Western Canada real estate and some potential impact to bank earnings.

Currency – USD/CAD  – Despite all the positive momentum in the US we think the majority of the move off the bottom has now occurred and we are mostly due for a pause. The U.S. dollar bottomed in late 2011 and has gained 23% adding significant gains to our U.S. equity holdings. The range we are looking at is $0.80 to $0.90. The expectation for further gains in the US dollar will continue as the longer term trend for the US is positive, the improving economy has helped bolster the U.S. government balance sheet and net export numbers continue to improve providing less of a headwind.  This currency trend will put additional pressure on Canadian investments vs. US investments – but we believe this pressure will be pretty small at this stage.

Interest Rates  – Similar to our views in 2014, we do not believe there will be significant moves higher on either the short or long end of the curve, but we do see some small increases later in the year. Global economic growth continues to have its challenges, deflationary concerns abound. Developed nations’ interest rates will remain near historical lows.

Bonds  – Do higher interest rates mean poor bond returns? The reality is that it depends on how you manage bonds. The first issue relates to higher interest rates. How much higher? We believe this will be limited to small increases. With the yield curve, do we focus on the short end (1 year or overnight) or the long end (10 years plus)? Much of the ‘flattening’ has already happened with sizable declines in long term rates in 2014. We see small changes at both ends. What about Government bonds vs. Corporates vs. High Yield? These decisions will shift throughout the year.

At TriDelta, we believe in an active bond strategy in order to take advantage of the shifts within the bond market, as much as the general trend. For 2015, this would likely mean taking advantage of some late 2014 trends. High yield bonds had a weak end of the year with worries in a few corporate sectors. We have taken some gains on Government Bonds of late, and will be looking at some Corporate and High Yield names that will benefit from a robust domestic economy. As for moving to the long end or short end, we have leaned longer and benefited by this for most of 2014. With the 10 year Canadian yield currently at 1.82%, we are taking a small pause as we feel there may be a better entry point for long bonds than we are at today.

Global markets – At TriDelta our focus is firmly on North American markets (US & Canada) and this for good reason as it is where the best risk adjusted returns have been in recent years. We do however monitor global markets and relative opportunity, and it is likely that our portfolios will reflect more of a global flavour as and when opportunities arise.

Global capital markets remain largely unattractive relative to the US & Canada. Most strategists cite the poor global GDP growth, which appears to have been priced into equity markets to a significant degree and this is a pre-requisite for future opportunities, particularly if, as and when growth & stability returns. For now we believe better risk adjusted opportunities exist in North American markets.

The Eurozone for example is fraught with uncertainty as they struggle with a multitude of issues such as high unemployment, Greece potentially exiting the euro and the more recent Russian risks and fallout. As a result these markets trade at a discount and may be headed even lower in the near term.

The emerging markets also remain an area of concern although we did invest a small amount due to its relative valuation in 2014. We do see opportunities particularly in markets that are commodity importers or energy importers.

Alternative Investments  –  Our view is that new investment asset classes are always worth reviewing. If we find something that we are comfortable with, we will incorporate it into our overall recommendations. If regulatory changes come about in Ontario in 2015, we will be able to offer some of these solutions to non-accredited investors as well. These strategies can include real estate, mortgages, business lending, factoring, and many others that emerge over time. With professional due diligence, there is an ability to find alternative income strategies that fit an investor’s goals, and that are not closely correlated to other investment markets.

We expect 2015 to be a positive year overall for clients, but with lower returns than most clients enjoyed in 2014. While these are predictions for the year, as information changes we will adjust our approach to take advantage on behalf of our clients. The key is to provide an investment portfolio that is open to all investment options available – and not limited to a small subsection of opportunities. In tandem, we need to be consistent with each client’s profile, what their goals are, and what their risks are. This investment discipline will serve clients well in sunny and stormy conditions. We are quite certain that 2015 will see some of both!

This report was written by the TriDelta Investment Counsel – Investment Management Committee.

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Wealth Advisor

For more information – please contact Ted Rechtshaffen, President and CEO, TriDelta Financial at 416-733-3292 x221 or tedr@tridelta.ca

TriDelta Q3 2014 Investment Report – Keeping the faith when the news is bad

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Executive Summary

5186232_s1Last quarter, our message was that Q3 is historically a positive quarter, but not as strong as Q1 and Q4. The message was also that we should expect to see our recent string of 1%+ monthly returns come to an end. Well it took until September, but it did indeed come to an end.

As the bad news from around the world seems to keep coming in, and people’s fears for the market escalate, TriDelta remains fairly confident in North American stock markets as we head into the fourth quarter. This isn’t because we are ‘fiddling while Rome is burning’. It is because:

  • corporate earnings remain strong
  • interest rates remain low (more on that further in our commentary)
  • the US economy is growing
  • you can buy BCE stock and get a 5.1% dividend that will grow every year or you can get a 5 year GIC at 2.5% that will not grow (and will get taxed more in a taxable account).

We recognize some of the challenges in the market and world, and are watching them closely but a big part of our job is to try to separate the meaningful information from the short term noise. For now, we believe that the meaningful information is telling us that stocks remain a better investment option than bonds or cash.

Two other notes on the month and quarter ahead. Only once in the past decade has a negative September been followed by a negative October on the Canadian and US stock markets. Of course, we all remember 2008 (sorry for reminding you).

As a final point, the broad US based S&P 500 has had a great run since March of 2009. However, within that run, the market has dropped 5%+ 11 different times, and each time has rebounded quite quickly and advanced further. As of this writing, for all of the noise, the S&P 500 still isn’t down 5% from its peak for a 12th time. While the TSX and other areas of the world were down more, the point is that these pullbacks are very normal, and we believe this is one more of them.

The Quarter that Was

The quick summary is decent numbers for bonds, a little weak for stocks, very weak for emerging markets, metals and mining and smaller cap stocks.

After a drop of 4.3% on the TSX in September, Toronto stocks ended the quarter down 1.2%.

The DEX Bond Universe saw a loss of 0.6% in September, and a quarterly gain of 1.1%.

Preferred shares saw small quarterly gains in the 0.5% range.

Both the S&P500 (US) and the MSCI World Stock Index had losses in September, and had similar quarterly returns with small gains of 0.6% and 0.4% respectively.

Currencies played a role in the quarter with the US dollar appreciating strongly against most world currencies and also to the Canadian dollar. Greater exposure to US dollar investments helped Canadian investor returns on the month. For example, while the S&P 500 was down 1.4% last month in US dollars, it was in fact up 1.6% on a Canadian dollar basis – for a 3% swing on currency.

How did TriDelta Clients Do?

Fortunately, most TriDelta Financial clients had a decent quarter.

Conservative clients did very well – with most up 1.5% to 2.5% on the quarter.

Growth clients were a little weaker – most were flat to slightly down on the quarter.

The reason that conservative clients did better was two-fold. Bonds and preferred shares outperformed most sectors of the stock market for the quarter, but within the stock market, large cap, dividend payers (outside of metals and mining) had solid returns, and these are the types of stocks that TriDelta owns in our Pension style portfolios. Of course, owning Tim Horton’s in Pension portfolios also helped.

Even in September, as the TSX was down over 4%, most of our Conservative clients (who are up between 8% and 10% on the year to date), kept September returns to a loss of less than 1%.

Over the long run Growth clients should outperform, but so far in 2014, our Conservative clients have seen better returns.

 

TriDelta High Income Balanced Fund

Some clients who are accredited investors ($1 million+ in investment assets or $300,000+ in household income or $200,000+ in personal income), have been able to invest in the TriDelta High Income Balanced Fund. This pooled fund aims to deliver high yields, and broad diversification, through stocks, options, and low cost leverage of bonds. Year to date the fund has returned just under 10%, and has been in the top decile (top 10%) of all balanced income funds in Canada. In Q3, the fund was up 0.7%. We are very pleased with the performance of the fund so far this year.

Pending legislation changes may mean that the Fund could be available to all non-accredited investors soon. We will keep you posted as soon as this change comes into reality.

Positive Dividend Changes Continue

We continue to pay close attention to dividend growing stocks. We believe that this is a strong part of long term, lower volatile investment success. Again this quarter we are pleased to say that there were no dividend declines, and the list of seven dividend growers are as follows:

Company Name % Dividend Increase Company Name % Dividend Increase
Home Capital +12.5% Emera +6.9%
Conocophillips +5.8% Royal Bank +5.6%
McDonalds +4.9% Verizon +3.8%
Bank of Nova Scotia +3.1%

The Quarter Ahead

10884799_sWe believe that interest rates are one of the biggest drivers of the market today, and the better handle we have on future interest rates, the better we will manage your overall portfolio. In summary, we believe that short term rates will rise in the US in late 2015, but only by a small amount. We believe that short term rates in Canada likely will track those of the U.S. – perhaps with some lag. We believe that long term rates in the US and Canada will remain fairly volatile, but could in fact move lower.

The basic message being that meaningful interest rate rises are unlikely to take place and that this helps guide our investments in two ways.

The first is that this will help the stock market as growth is encouraged by low borrowing costs.

The second is that long term bonds are a reasonable investment as well, and are not to be feared.

Here are 6 items driving our view of interest rates:

  1. “Everyone” thinks interest rates are going higher, but the market seems to be telling us something different. This can most easily be seen in the 10 year bonds in virtually all Western countries that have seen meaningful declines in 2014 – most notably in Europe.
  2. Yes it is true that Quantitative Easing will end by the end of this year, but US long term interest rates have actually fallen during most of the months that the US government has been reducing its bond buying. The noise about the end of Quantitative Easing has upset the market, but the reality is that long term interest rates may come down further from here. Don’t get caught up in the noise.
  3. Short term rates in the US are going to rise in 2015 – but it will likely be so small that it won’t make much of a difference? Fed Funds Futures currently give a 75% chance that the first US rate hike will be around September 2015 (still almost a full year away). There is a 50% chance of a second hike of 25 basis points (0.25%) by the end of 2015. IF both happened it would move the US Fed Funds rate from 0.25% all the way to 0.75%. This would mean that in 12 to 15 months, the US Fed Funds rate will still likely be at close to historical lows.
  4. Geopolitical risks (Russia, ISIS and Hong Kong) are providing a safe haven trade into bonds – especially in the US and Canada. This flood of funds into bonds is keeping interest rates low.
  5. As the largest debtor nation in the world, the United States doesn’t want to have to pay more on their own debt. Just like you want your mortgage rate to be low, imagine how much a country with $18 trillion of debt would like to have low interest costs!
  6. Household debt levels are significantly greater now than before the financial crisis. If the US Fed hikes rates prematurely, there is a risk of a recession.

Summary

While you don’t want to sift investment decisions down to a couple of numbers, we do feel that today, interest rates play a bigger predictor of future stock market returns than they have in a long time.

Fortunately for us, our view is that long term rates in particular, will be supportive of higher equity markets, particularly in the U.S., for the period ahead. Corporate earnings remain very important and have been largely positive of late, but we believe that low interest rates will also be key to continued earnings growth.

As an aside, investment markets tend to perform better from October to March than the 6 months that have just past. Let’s hope that trend continues.

May we all enjoy the beautiful fall colours that Canada provides, and remember to take time to be thankful for the good in our lives.

 

TriDelta Investment Management Committee

 

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Wealth Advisor

 

 

TriDelta Investment Counsel – Q1 2014 investment review

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Executive Summary

After strong investment markets in 2013, there were some real questions about valuations heading into 2014.

At least for the beginning quarter of the year, we remained fully invested and leaned a little aggressively. This has paid off as the quarter was quite positive for stocks (more so for Canada than the US). Even bonds and preferred shares had a bit of a rebound, continuing some of their gains from the last quarter of 2013.

The question remains whether to take a little bit off the gas to defend against a potential pullback or to continue to move fully forward.

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TriDelta Investment Counsel – Q4 2013 investment review

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Equities maintained strong upward momentum during the fourth quarter of 2013 completing an excellent year. The sustained & better than expected US economic reports, fueled a global market surge that surpassed our expectations.Virtually every major global equity market was up double digits for the year with a few notable exceptions including China and Brazil. Indications suggest that the global recovery following the major market shocks in 2007 & 2008 has taken hold. The recovery is being led by the US economy and is believed to be sustainable although will likely deliver its fair share of surprises as it unfolds further.Emerging market equity returns were slightly positive in the fourth quarter, but as a group recorded slightly negative returns for the year.

Precious metals remained under pressure throughout the quarter and were well down on the year. Gold investors recorded a negative 28.3% return.

Fixed income on the other hand showed signs of stress in light of the broad based US economic strength, exasperated by talks of the US Federal Reserve tapering. Most global bond indices were flat or slightly negative. The DEX Universe of Canadian bonds recorded its first negative return of -1.19% in well over a decade. Losses were driven by government issued debt and bonds with longer maturity dates while corporate bonds in aggregate returned 0.84% for the year.

 

The Bank of Canada remains concerned that inflation remains well below target, but is also troubled by record high consumer debt levels spurred by low interest rates. This dilemma suggests that they will likely remain neutral (in other words, not increase rates) for some time.

Despite the difficulty of double guessing the Bank of Canada, our opinion is that longer dated bond yields may rise albeit not for some time. Once Canadian rates move higher increases will likely remain within a tight range between 2.5% and 3%.

16413399_sWe reiterate that bonds have a key role to play as part of very necessary diversification as we build wealth. We also focus on capital preservation while delivering clients with a steady stream of predictable income. We forecast that our bond portfolios will deliver an approx. 3.5% return in 2014.

In 2013 our Core bond portfolio returned 3.68% and our Pension bond portfolio 1.66%, despite our benchmark DEX losing 1.19%.

US Fed policy remained the big discussion amongst market strategists who debated timing and the extent of QE tapering. December delivered the first decision to begin the easing process with a $10 billion monthly reduction of bond purchases from $85 to $75 billion starting in January 2014. The fear of tapering hindered 2013 bond performance, but we believe it is no longer a big issue and that bond markets have now priced in the effect of eliminating it entirely in 2014.

Despite the positive economic news including the IMF and World Bank forecasts of better global growth in 2014, caution is warranted, particularly after the steep market gains. Our ‘TriDelta 2014 Financial Forecast’ published in late December details our outlook for the year ahead.

How did we do?

2013 was another positive year for TriDelta clients. The Toronto Stock Exchange equity index (TSX) returned 7.3% in the fourth quarter and 13% for the year whilst the Canadian Corporate bond component of the DEX Universe Index was up 0.87% for the year while the overall DEX Universe was down 1.19%.

Most TriDelta clients had a net return for their portfolio between 6% and 16% depending on their risk tolerance/asset mix. Pure equity returns before fees were 22.45% for our Core portfolio and 18.41% for our Pension portfolio.

TriDelta Equity Model Returns in Canadian Dollars (to December 31, 2013):

TriDelta model 1 month 3 month 6 month 1 year (2013)
Core Equity 1.60% 6.64% 9.97% 22.45%
Pension Equity -0.15% 7.44% 11.64% 18.41%

 

What worked well in Q4?

Sectors: Info Tech +15.7%, Industrials +16.8% & Health Care +13.8%

Core Model Stocks: Core – Constellation Software +24.5%, 3M +22%, Priceline +18.8%

Pension Model Stocks: Norfolk Southern + 24.8%, Abbvie +23%, Apple +22.3%

What did not work well in Q4?

One of our beliefs at TriDelta is to be very open about our business, its successes and its weaknesses. Openness is not a hallmark of the financial industry, but something that we believe is important in order to build trust, strong performance and partnership with our clients.

Sectors: Materials +0.8%, Utilities +4.7%

A few of our holdings had negative returns, some of which are listed below:

Core Model Stocks: Manitoba Tel -11.1%, S&P 500 Short -9.4%, Tourmaline -4.5%

Pension Model Stocks: Iamgold -13%, S&P 500 Short -9.4%, Cdn Oil Sands -.9%

The Best and Worst performers of 2013

Pension portfolio:

Company Name Change
Abbvie +68%
Norfolk Southern +64%
Home Capital +39%
Wajax -12.7%
Iamgold -12.9%
Potash -15.2%

 

Core portfolio:

Company Name Change
Priceline +99.9%
Magna +78.6%
3M +64.8%
Marathon Petroleum -15.2%
Barrick Gold -17.0%
Coastal Energy -17.7%

Dividend changes:

We strongly believe in the power of dividend growth and those companies who have a history of increasing their dividends over time. These companies have generally outperformed the market with lower volatility. This quarter was no exception and we were proud to own the following companies that increased their dividends:

Company Name % Dividend Increase
Abbott Labs 57%
3M 34%
Atco Ltd 15%
Canadian Utilities 10%
National Bank 6%
McDonalds 5%
Merck 2%
TD Bank 1%

One company we owned removed their dividend entirely, which was a disappointment. It was Iamgold Corp

Summary

We’re proud to have protected and grown our client wealth in 2013.

We have also successfully delivered on our core beliefs of comprehensive financial planning, tax efficiency and an investment plan that generally lowers volatility, typically increases income and ensures we own many of the best companies as identified by our exclusive quantitative led selection process.

2013 is another example of our achieving above average risk adjusted returns in an extremely low interest rate environment. We remain committed to our proven investment approach and philosophy.

Thanks for your continued support.

 

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Wealth Advisor

TriDelta Investment Counsel 2014 Forecast

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As 2013 comes to a close, we thought that it would be a good time to share our expectations for 2014 and discuss our views on the current year.  In 2013, we expected US equities to outperform Canadian equities.  Our fairly large exposure to US equities (vs. many other Canadian Investment Counsel and brokerage firms) benefitted clients.  In the Canadian market, dividend paying, low volatility stocks, such as utilities, banks, insurance companies and telecommunications significantly outperformed natural resources.  Industrials, such as Magna International and Air Canada also performed extremely well.  On fixed income, while the Canadian Bond Index (DEX Universe) had a slightly negative return, our focus on corporate bonds has enabled our clients to earn slightly positive returns during the year.

As we approach 2014, we are hopeful that the US clarity on bond tapering will give the market confidence, that Europe will finally experience GDP growth, that Abenomics will provide a further economic boost in Japan, that Canada will continue to expand and be known for innovation and growth instead of just for Rob Ford, and that we at TriDelta will continue to provide strong returns for our clients to meet their investment and financial goals.

 

2014 Predictions:

TriDelta Financial 2014 Predictions
TSX Total Return 6%
S&P 500 Total Return (in US$) 8%
DEX Canadian Bond Index Total Return 1.75%
Canadian Bank Prime Rate 3% Remain Unchanged
10 Year Gov’t of Canada Bond Yield 2.50% to 3.00% Little meaningful rate increase
Canadian Dollar vs. US$ at year end 90 cents

US Equities over Canadian Equities – While we do not expect a repeat of last year, we do expect US equities to produce medium to high single digit returns (6-9%).  Historically, the US equity market has experienced positive returns following a strong performing year like 2013.  The difference is that while 2013’s equity returns were based mainly on valuations, with Price-Earnings multiples expanding and roughly 6% earnings growth, 2014 will be mostly earnings growth as companies try to meet or beat the lofty 10% growth expectations.   We expect that the US economy should grow at a faster pace than in 2013.  We also anticipate that with 2014 being an election year, there will be little in the way of significant debt reduction agreements, removing a further concern against equity markets going higher.

Due to the extent of the recent increase, we think there could be a pullback in the near-term hence our holding of the S&P500 Inverse ETF.

Canadian Equities – We expect positive returns for the TSX in 2014 as well.  Valuations for many of the dividend payers remain quite reasonable, especially in a low interest rate environment.  We again expect the non-resource sectors, such as financials, telecommunications, transportation and industrials to outperform.  Having said this, we believe that the TSX will still likely underperform the US markets.

Sectors to Outperform – The last few years have been all about dividend paying stocks.  We think next year could see a number of cyclical companies outperform, such as Industrials hence our weighting in Goodyear Tire & Rubber US (GT) and Magna International (MG).  While the overall technology sector is trading at high multiples thanks to companies like Twitter, there are a number of bellwether technology companies, such as Cisco Systems (CSCO) that are trading at relatively low multiples, offering strong balance sheets, good dividends and cash flow.  2014 could also be the year when mining stocks finally hit bottom.  While we think there may be some excellent opportunities in the sector, we also believe that it is presently too early to invest.

World Economy to Expand Moderately – The IMF is predicting 3.6% growth for the world in 2014, a significant increase from their current forecast for 2013 of 2.9%.  Overall, a greater portion of this growth is expected to come from the developed countries.  Europe and Japan are both projected to grow by over 1% and North America by 2.5%.  Emerging markets are forecast to grow by 4.5%; China will account for a significant portion of that growth at 7.3%.

2014 will also mark the 100th anniversary of the beginning of World War I.  We need to sometimes remember that the first European Union, the European Coal and Steel Community (ECSC) in 1951 was not only founded to encourage economic growth, but as French Foreign Minister Robert Schuman stated, the ECSC was “to make war not only unthinkable, but materially impossible”.  We believe that the European economy may have turned a corner recently and with equity valuations a little lower than in North America, this may be an area we add strategically to client portfolios.

Bonds – We favour equities over bonds in 2014.  Within fixed income (bonds) we favour corporates and high yield over governments.  We expect that the US Federal Reserve will begin to taper its quantitative easing bond buying process in the Spring of 2014 or earlier; however, any acceleration of timing would not be a shock to the market,  and the process will be very gradual.  To temper any fear and confusion that tapering is not tighter monetary policy, we do not expect interest rates to rise meaningfully in 2014.  As a result, we think that interest rates on the 10 year Canadian government bonds are range bound between 2.50% to 3.0%.

Corporate bonds will continue to offer favourable returns in a low interest rate and inflation environment.  Investment grade corporate bonds in the 10-year to maturity area are offering yield premiums of around 150 basis points (bps)  vs. comparable government bonds.  High yield bonds in the  universe are typically offering yield premiums of roughly 425 bps.  There is a need to be selective in terms of credit and allocation along the yield curve to provide the highest potential return vs. risk, but in general Canadian and US issuing companies are in strong financial positions with solid balance sheets.

Currency  – The US dollar ended 2012 at a slight discount to the Canadian dollar, but has appreciated by over 7% during 2013 into December.  We expect that the US dollar will continue to appreciate as the longer term trend is turning positive, the improving economy has helped bolster the U.S. government balance sheet and net export numbers continue to improve providing less of a headwind.  This currency trend will put additional pressure on Canadian investments vs. US investments.     

Alternative Investments  –  Over the past year, we have begun supplementing alternative investments to the portfolios of certain accredited investor clients, to gain access to asset classes that cannot easily be purchased on public markets, such as mortgages, real estate, infrastructure and private credit or strategies that can cost effectively use options and leverage.  Recently we launched our first pooled fund, TriDelta High Income Balanced Fund, which employs institutional investment strategies, such as options and leveraged fixed income.  We believe that our new fund and other alternative strategies can add to client returns, while reducing volatility.

While we expect 2014 to be a positive year overall for clients, we do expect volatility to increase from its low levels this year.   As such, we will continue to review economic indicators, trends and relative value to proactively take advantage of opportunities and reduce risk when deemed appropriate.

 

This report was written by the TriDelta Investment Counsel – Investment Management Committee.

Members include: Cameron Winser, VP, Equities; Edward Jong, VP, Fixed Income; Lorne Zeiler, VP, Wealth Advisor; Ted Rechtshaffen, President and Wealth Advisor; and Anton Tucker, EVP, Wealth Advisor.

For more information – please contact Ted Rechtshaffen, President and CEO, TriDelta Financial at 416-733-3292 x221 or tedr@tridelta.ca

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