Slow and Low

By David Dittman • September 5, 2014 • In Brief

Editor’s Note: What follows is the executive summary of the September 2014 issue of Canadian Edge. Thanks for reading.

Publication of Canadian Edge, usually on the first Friday of every month, regularly coincides with employment reports from responsible government agencies on both sides of the US-Canada border.

Jobs numbers, despite the fact that initial figures represent mere estimates based on broad surveys, inevitably inspire heated interest in the anticipation and outsized reaction in the event.

Before we go any further, please note that initial reports from Statistics Canada and the US Dept of Labor Bureau of Labor Statistics (BLS) are always, without fail revised. And lately those revisions have been of the “upward” variety.

The US release, because it provides a snapshot of the biggest economy on the planet, moves markets much more than the Canada release. But both get way too much attention. In fact no single data point, economic indicator or market metric should inspire portfolio-altering moves.

Nevertheless, the BLS report on Friday morning, Sept. 5, sent US Treasury prices soaring. Stock futures’ reaction was a little more nuanced and a lot more ridiculous.

Government bonds had been weakening early this morning, with the 10-year note down 5/32 in price to yield 2.468 percent just prior to the report’s release and the 30-year bond down 11/32 to yield 3.223 percent.

Within minutes of the BLS “Employment Situation” release the 10-year note was up 12/32 to yield 2.403 percent and the 30-year bond was up 12/32 to yield 3.183 percent.

Stock futures had fallen between 0.1 percent and 0.3 percent prior to the report but reversed soon after its release. In this crazy, mixed-up world the equities market likes anything that might dissuade the US Federal Reserve from making its first interest-rate hike since 2006.

The “smart money” says the Fed will act by mid-2015 to take the benchmark federal funds target rate off the “zero bound.”

There remains a great deal of fear/certainty that this great rally is being driven/supported by easy monetary policy, though we should be reminded that we’re nearing the end of “quantitative easing” and key equity benchmarks, including the S&P 500 Index, the Dow Jones Industrial Average and the S&P/Toronto Stock Exchange Composite Index, continue to push out to new all-time highs.

The US added 142,000 new jobs in August, breaking a streak of six straight months of payroll growth of more than 200,000.

The unemployment rate declined slightly to 6.1 percent from 6.2 percent in July, but this decline was due to a 64,000-person drop in the labor force to a seasonally adjusted 62.8 percent from 62.9 percent.

The participation rate once again tied the lowest level since the late 1970s. But the survey on the labor force is volatile from month to month, so it’s important to look at longer-term trends.

In the past year the labor force is up 524,000 while civilian employment is up 2.2 million, driving the jobless rate down to 6.1 percent from 7.2 percent a year ago.

The aging of the Baby Boomers will keep putting downward pressure on the participation rate but the participation rate will remain flat to slightly up as improvement in job opportunities temporarily offsets population aging.

The consensus expectation was for payroll growth of 225,000 and a jobless rate of 6.1 percent.

Notably, July’s job gains were revised mildly higher to 212,000 from 209,000.

Now step back to September 2011 to the BLS’ initial report on “The Employment Situation” for August 2011, which showed zero payroll growth. It was largely interpreted as a sign of impending recession.

Revisions in October and November took the August 2011 number up to 104,000. The same thing happened in August 2012 and August 2013: a weak initial report followed by big upward revisions.

Average hourly earnings were up 6 cents and have now risen 2.1 percent year over year, slowly rising toward the Fed’s target level. And total hours worked are up 2.1 percent from a year ago as well. Total cash earnings are up 4.2 percent from a year ago, more than enough for consumers to keep increasing spending.

The bottom line is that it’s important not to read too much into the August report. Recent years have seen big upward revisions in subsequent months, and this time will probably be no different.

Demographics and Destiny

Let’s return for a moment to the issue of the Baby Boomers and their impact on the labor force participation rate. In fact let’s broaden the issue and talk about that famous cohort’s impact on economic growth generally.

There’s a powerful argument rising among economists that the global economy moved into an era of slower growth some time ago. The Global Financial Crisis/Great Recession, a dramatic, relatively short-term event that happens about once a century, obscured this phenomenon.

But the broader context is of an aging and wealthy world, with slowing technology growth and growing income inequality.

The developed world is much older today than in any time in modern economic history due to advances in medicine. People are living longer, raising incentives to save rather than spend, as older folks tend to live off their savings rather than income.

A new e-book published on Aug. 15, 2014, by the Centre for Economic Policy Research on the concept notes that the required amount of money for saving in Germany “rose from almost two times GDP in 1970 to three and a quarter times GDP in 2010.”

Similar trends are happening across the wealthy world, creating a lot of demand for safe assets like US government debt and pushing down interest rates over time.

But it’s not just the aging of the population that we have to contend with, but slowing population growth overall. The slowing of population growth means companies have less incentive to invest in the future because there’s little reason to believe that there will be demand for their products, a dynamic that also feeds into lower overall interest rates.

I’m not willing to buy whole-hog the “secular stagnation” conclusion. But it is a compelling explanation for the jagged, lumpy and unsatisfying recovery from the Global Financial Crisis/Great Recession experienced here in the US and all over the developed world.

David Dittman
Chief Investment Strategist, Canadian Edge

Portfolio Update

One CE Portfolio Aggressive Holding and four Conservative Holdings pushed out to new 52-week highs over the past five days as we put together the current issue, including Newalta Corp (TSX: NAL, OTC: NWLTF), EnerCare Inc (TSX: ECI, OTC: CSUWF), Keyera Corp (TSX: KEY, OTC: KEYUF), Pembina Pipeline Corp (TSX: PPL, NYSE: PBA) and TransForce Inc (TSX: TFI, OTC: TFIFF).

Several other members of the How They Rate coverage universe did so as well.

Another eight Aggressive and Conservative Holdings established new 52-week highs following publication of the August 2014 issue of CE.

Many more members of How They Rate did as well.

It’s a diverse group. In fact the Oil and Gas segment lacks representation among those making new near-term highs in recent weeks, a direct reflection of softer commodity prices.

It’s important to note too that major equity indexes–including the S&P 500, the Down Jones Industrial Average and the S&P/Toronto Stock Exchange Composite–are trading at or near new all-time highs as well.

In recent months that’s been cause for angst among many market observers and pundits.

But let’s look at the historical record: The data reveal that one of the most bullish things that can happen to any market is for it to reach new multi-year highs.

We have more on this topic and we break down second-quarter earnings reports from Bird Construction Inc (TSX: BDT, OTC: BIRDF), EnerCare Inc (TSX: ECI, OTC: CSUWF), Northern Property REIT (TSX: NPR-U, OTC: NPRUF), Ag Growth International Inc (TSX: AFN, OTC: AGZFF), Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF), Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF) and Wajax Corp (TSX: WJX, OTC: WJXFF) in this month’s Portfolio Update.

Best Buys

In the August 2014 In Focus feature we discussed 10 buy-rated companies in the How They Rate coverage universe, many of which have attributes befitting Portfolio Holdings.

In fact we explicitly referred to Dream Industrial REIT (TSX: DIR-U, OTC: DREUF), in the subhead introducing it in that article, as “The Next REIT” in line for promotion to the Conservative Holdings.

Although we weren’t as explicit in our discussion of Baytex Energy Corp (TSX: BTE, NYSE: BTE) and its potential for inclusion in the Aggressive Holdings, the company’s production-per-share growth profile, its solid and growing asset base, management’s record of execution and an exceptionally attractive yield make it at least the fifth-strongest Oil and Gas recommendation in the coverage universe.

We noted in last month’s Portfolio Update our concern regarding Conservative Holding Dream Office REIT (TSX: D-U, OTC: DRETF), particularly its unit-price performance relative to other Canadian real estate investment trusts (REIT).

Dream Office is outperforming the broader office market in Canada, and it continues to put up solid financial and operating numbers. But we have better alternatives, including its affiliate Dream Industrial REIT, which is exposed to the more favorable industrial market.

With a yield north of 6 percent and three promising core plays–including Peace River and Lloydminster in addition to the Eagle Ford–Baytex is a solid growth-plus-income option for energy investors.

We’re adding it to the CE Portfolio Aggressive Holdings as a de facto replacement for hold-rated Lightstream Resources Ltd (TSX: LTS, OTC: LSTMF), which faces continuing pressure to maintain its dividend in the face of asset sales and softer crude oil prices.

Best Buys has more on the Portfolio Holdings that represent our top ideas for new money in September.

In Focus

The immediate market reaction to another stellar quarter of financial and operating results for Canada’s Big Six banks was generally negative, with four of them suffering appreciable share-price declines the day they revealed fiscal 2014 third-quarter numbers.

It’s a matter of Bank of Montreal (TSX: BMO, NYSE: BMO), Bank of Nova Scotia (TSX: BNS, NYSE: BNS), Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM), National Bank of Canada (TSX: NA, OTC: NTIOF), Royal Bank of Canada (TSX: RY, NYSE: RY) and Toronto-Dominion Bank (TSX: TD, NYSE: TD) beating expectations…but not by enough to satisfy ever-harder-to-please investors.

Canada’s banks–reputed to be among the safest, most stable financial institutions in the world–have also established a remarkable track record of exceeding analysts’ earnings forecasts. It’s now a matter of course when one, several and all of them do so in a given quarter.

So the short term may in many cases be unfairly unkind. But performance for the three months ended July 31, 2014, provides additional reason to believe in Canada’s Big Six for long-term dividend growth.

In Focus takes a look at fiscal 2014 third-quarter earnings for Canada’s Big Six banks, including Conservative Holding Scotiabank, with details on recent dividend growth and an upgrade for TD Bank.

Dividend Watch List

There was one dividend cut in the How They Rate coverage universe over the past month, as Spyglass Resources Corp (TSX: SGL, OTC: SGLRF) broke a two-month cut-less streak due to a need to save cash for debt reduction and to fund its capital expenditure program.

Dividend Watch List has the details on members of the How They Rate coverage universe whose current dividend rates are in jeopardy.

Canadian Currents

After a disappointing first quarter, the country’s economy is humming again, notes CE Associate Editor Ari Charney in this month’s Canadian Currents.

Bay Street Beat–Second-quarter reporting season has come to a close for the Canadian Edge Portfolio.

Here’s how Bay Street reacted to financial and operating numbers and how it sees our Conservative and Aggressive Holdings as we near the end of the third quarter.

How They Rate Update

Coverage Changes

Equal Energy Ltd (TSX: EQU, NYSE: EQU) has been acquired by Petroflow Energy Corp and has been de-listed from How They Rate.

Our evaluation of the coverage universe is ongoing, as we streamline our focus to companies with realistic opportunities to build wealth for investors for the long term, keeping in mind too that part of the rationale for building a coverage universe is to provide context and comparison.

Advice Changes

Toronto-Dominion Bank (TSX: TD, NYSE: TD)–From Hold to Buy < 58. TD Bank has an impressive track record of dividend growth, and its significant exposure to the US is turning into a strong positive as growth in the world’s largest economy continues. Fiscal 2014 third-quarter numbers were solid.

Tim Horton’s Inc (TSX: THI, NYSE: THI)–From Buy < 58 to Hold. The share price has soared to CAD88.20 on the Toronto Stock Exchange (TSX) and USD81.08 on the New York Stock Exchange (NYSE) as of the close of trading on Sept. 5, 2014, from CAD68.40 and USD62.34, respectively, on Aug. 8, as the iconic Canadian coffee-and-donuts franchise has agreed to be acquired by Burger King Worldwide Inc (NYSE: BKW) for CAD94.05 per share.

Rating Changes

Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF)–From 0 to 1. The regional air carrier earns a point because its payout ratio based on the current annualized rate of CAD0.45 represents 62.5 percent of trailing 12 months’ earnings.

The core of my selection process is the six-point CE Safety Rating System, which awards one point for each of the following. A rating of “6” is the safest:

Payout Ratio–A ratio below our proprietary industry baseline.
Earnings Visibility–Earnings are predictable enough to forecast a payout ratio below our proprietary industry baseline.
Debt-to-Assets Ratio–A ratio below our proprietary industry baseline.
Short-Term Debt Ratio–Debt due in next two years is less than 10 percent of market capitalization.
Business Stability–Companies that can sustain revenues during recessions are favored over more cyclical ones.
Dividend History–No dividend cuts over the preceding five years.

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