The mood of stock markets has turned brighter, and clients weary of sitting on the sidelines in cash or struggling with paltry returns on bonds are taking a fresh look at equities.
Fund portfolio managers and clients brave enough to buy stocks during the past few years – when many people were shunning them – have been savouring juicy gains recently. But those who did not buy face the challenge of deciphering where opportunities lie.
“There is still a lot of stuff to worry about,” says Keith Graham, president of Toronto-based Rondeau Capital Inc. and subadvisor to NexGen Turtle Canadian Equity and NexGen Turtle Canadian Balanced funds, sponsored by NexGen Financial LP of Toronto. “I’m still driving forward, but it’s not pedal to the metal at 100 miles an hour. It’s more like driving through a snowstorm on an icy road.”
Many clients who have come back to the equities market during the past couple of years have gravitated to income-oriented stocks that pay out a large share of their cash flow in high dividends. These so-called “safe stocks” are closer to bonds than growth-oriented investments that have more potential for expansion and capital gains, such as pipelines, utilities, real estate investment trusts (REITs) and telecommunications firms. But popularity has bid up the price of these income-oriented investments, to the point that many value-oriented fund managers are no longer finding attractive prices. For example, during the five years ended Dec. 31, 2012, the S&P/TSX composite index rose by an average of 0.8% a year, while pipelines rose by 14.3%, telecoms by 6.9%, REITs by 10.9%, banks by 7.7% and utilities by 4.4%.
“If you buy a good business at a bad price, you have not made a good investment,” says Graham. “Some of the riskier businesses are being valued at attractive levels at which there is actually less risk than a traditional low-risk business trading at a high price.”
Graham is picking carefully among individual names where the field is less crowded. For example, he likes Cenovus Energy Inc., an integrated oil company that he expects will be a leader in the next wave of oilsands development – much like Suncor Energy Inc. was a decade ago. Graham also is sniffing around the senior gold producers, whose stock prices have been treading water for several years. Fund portfolio managers, he says, have recently become more prudent regarding capital expenditures, acquisitions and bringing projects to completion on time.
“Gold companies have been out of favour for a long time, and the valuations look interesting,” he says. “But I’m a shopper; I’m not jumping in.”
@page_break@Many market observers believe the expansionary policies of various national governments could result in deteriorating purchasing power of paper currencies and, ultimately, boost demand for gold.
“Gold cannot be printed by central banks and is a monetary metal that is no government’s liability,” says a recent report by David Rosenberg, chief economist and strategist with Gluskin Sheff + Associates Inc. “With the gold-mining stocks trading at near record-low valuations relative to the underlying commodity and the group so out of favour right now, anyone with a hint of contrarian instinct may want to consider building some exposure – as we have begun to do.”
Another sector that is attracting value-seekers is the Canadian energy sector, in which stocks have been hit by a variety of forces, including a shortage of pipeline transportation to export markets, an unfavourable disparity in the Alberta crude oil price relative to world prices and growing competition from U.S. shale gas.
Jennifer McClelland, co-manager of RBC Canadian Equity Income Fund and senior portfolio manager and vice president of RBC Global Asset Management Inc. of Toronto, says pessimism regarding the energy sector has kept it from receiving much of the recent market inflows. However, the RBC fund is making a “gradual tilt” toward increasing exposure, she says: “The change is at the margins – it’s not drastic, but energy is an area worth watching.”
Alan Mannik is vice president of the Trimark Investments unit of Toronto-based Invesco Canada Ltd., co-manager of Trimark Canadian Fund and lead manager of Trimark Canadian Opportunities Class Fund. He says the Trimark team looks for ideas where few people are looking, and energy is currently out of favour.
Although transportation issues and competition problems are currently depressing stock prices in the energy sector, Trimark takes a five-year horizon when assessing the prospects of an investment – and Mannik believes these problems will be resolved. New transportation capacity, either pipelines or railcars, will be built. Although this will be a multi-year process, he adds, the market is likely to discount these events well in advance.
One company Mannik likes is Total Energy Services Inc., which rents out oilfield equipment, such as liquid storage tanks, lighting and rig mats. Total Energy has more locations than its competitors and can move equipment to wherever activity is greatest. Mannik also thinks highly of the firm’s management team.
“Good companies find opportunities to create value, regardless of the external environment,” Mannik says. “Total’s management has demonstrated this in past downturns by buying assets from weaker competitors, often at very attractive prices.”
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