INVESTMENT INSIGHTS FROM OUR EXPERTS

EQUITIES COMMENT – “Smooth Sailing”

October 12, 2016

 

Low Volatility a Trademark for the Quarter

Unlike last summer, we did not have days of gut wrenching volatility in global equity markets. Below we show a graph of the Volatility Index (VIX) which measures the up and down movement of the S&P/TSX 60. As you can see, the VIX has been very subdued, ranging between approximately 10 and 17. Last year, the VIX went below 10 and then shot up over 30 in August. Record low bond yields, delays in a Federal Reserve rate increase in the U.S., signs of an improvement in U.S. corporate earnings and complacency about a Clinton win contributed to the favourable environment for stocks.

 

 

 

TSX Composite

Mining stocks have led the rally on the back of a higher gold price and improvement in base metals prices like copper and coal. Teck Resources has been the top performing stock in the TSX 60 with a return over 300% year to date. The energy sector is up 27% due to the recovery in oil and decline in bond yields. Pipelines and energy producers have performed better than the less cyclical integrated companies. A number of other sectors are posting solid but less spectacular returns of 9% or more such as consumer, financials, industrials, telecoms and utilities. After this year’s gains, we expect the TSX to provide a more modest return in 2017. Our target is 15,500 which would translate to a return including dividends of 8%. This forecast assumes we don’t hit any rocks or run into thunderstorms like a Trump presidential win, another exit from the EU, severe slowing in China or faster than expected Federal Reserve rate increases.

 

 

 

The Big Get Bigger

In a slow growth, low inflation economic environment, how does a company drive sales growth? How about buying out one of your competitors? Right away your sales are up and because there will be some overlap in costs, there will be ways to cut back and increase profits. Low interest rates make the economics of such deals even more attractive. Merger and acquisition activity among Canadian stocks has been high this year.

 

 

One of the reasons that the large cap blue chip stocks we prefer to invest in do just as well, if not better, than smaller companies is because they can take advantage of economies of scale to reduce their costs and increase profitability. Also, when their markets are in a downturn, they have the financial strength to acquire companies at attractive prices so they are better positioned for a recovery in their business when it occurs. We believe these deals will put the wind in their sails over the long term.

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