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Spr ing 2012
Escarpment Magaz ine
Global equities
and in particular, US equities, have been
the bane of Canadian investor portfolios for the last 10 years.
Lackluster returns and a Canadian currency appreciation of
over 35% have made them poor places for capital. Con-
versely Canadian equities have had the wind at their backs
(relatively speaking) during the same ten year period.
For our managed portfolios in mandates where we can allo-
cate outside Canada we have been massively underweight.
We ignored the “Canada is only 3% of the global market-
place”, “some of the best companies are not in Canada” and
the Canada Pension plan has over 30% in international allo-
cations and we have kept a very strong home country bias.
That began to change for us a year ago.
We do not think we have the skills set to make market calls
and make allocations on global macro economic trends. We
leave these to others more brave, more foolish or smarter than
us. We began to make slow incremental changes because of
what our stocks and valuations were telling us. Canadian
stocks simply are more expensive than their US and Global
counter parts. Much (but we do not think all) of the currency
risk is behind us.
The poster child for us, and last year’s market darling, En-
bridge drives the point home. At time of writing, $1 of En-
bridge earnings would cost $29, for a price earnings (P/E)
multiple of 29X. Price earning multiples are commonly used
valuation tool. A way to think about Enbridge’s P/E of 29 is
that it would take Enbridge 29 years to earn its current stock
price. A P/E multiple that like would be reserved for a tech
stock, not a utility. We can blame the blind quest for yield,
passive index and ETF strategies that focus on income for driv-
ing up many of the P/E multiples of stocks. It can become self
fulfilling in that more and more money gets plowed into a nar-
row group of stocks until…….it does not anymore, it can end
badly. Too much money chasing too few stocks. This phenom-
enon drove the rise in the S&P 500 in the late 1990’s to end
in disaster in 2000.
The utilities and pipeline sectors in Canada are in my opinion
fully valued with only a few companies offering reasonable
relative valuations. This is where the US comes in. There are
quite a few US utility stocks that investors can buy at P/E of
less than 10. On a P/E basis, one third the cost of Enbridge
and many have dividend yields almost double. This is a func-
tion of how much American investors have avoided their mar-
kets over the last three years. I think the Americans will
eventually come to the same conclusion that Canadians did
over two years ago.
Buying inexpensive companies that provide demand inelastic
goods or services and provide dividend yields in excess of 3%
is going to be much more attractive than Federal Bonds pay-
ing less than 1% and offered by a dysfunctional and prolifi-
gate government (this is why we are very careful with any
government bonds – including Canada). Risk free is not what
it used to be. We just don’t know enough politicians anywhere
who have the courage to tell people you should not spend
more than you earn.
There are risks. The US dollar is not out of the woods yet. It is
hard to see a solution in the intermediate term to the debt and
deficit problems in the US and anywhere in the western world
(save Australia who have nearly paid off their national debt),
and that includes Canada when you throw in the provinces
and unfunded Pension and Health Care commitments.
Notwithstanding the currency risks, when you can buy similar
companies to those in Canada for .33 cents on the dollar, you
do have a lot of room for currency changes.
The compelling valuation stories are not just the utilities but
also the banks (think retail and region banks not the investment
banks), healthcare companies and blue chip multinationals
selling at a fraction of their former value but with earnings and
balance sheets in much better shape.
We have looked at strategies for managing currency risk and
there are a number of ETFs (which we use) and mutual funds
that hedge the currency risk. Innovations in hedging have
made the cost of hedging a fraction of what it used to be and
are worth exploring.
It may be time to review your portfolio and allocations outside
of Canada. We may have won the war of 1812 but in 2012
and for the next little while the edge may go to Uncle Sam.
After more than ten years they just may be due.
|E|
Peter Hodgson CFA is a Vice President and Branch Manager as well as a Portfolio Manager with BMO
Nesbitt Burns in Collingwood. If you have any questions, please call 705-446-2094. If you are already
a client of BMO Nesbitt Burns, please contact your Investment Advisor for more information. Opinions
are those of the author and may not reflect those of BMO Nesbitt Burns. The information and opinions
contained herein have been compiled from sources believed to be reliable but no representation or
warranty, express or implied, is made as to their accuracy or completeness. BMO Nesbitt Burns is a
member CIPF. All insurance products and advice are offered through BMO Nesbitt Burns Financial
Services Inc. by licensed life insurance agents, and, in Quebec, by financial security advisors. The
comments included in the publication are not intended to be a definitive analysis of tax law: The com-
ments contained herein are general in nature and professional advice regarding an individual’s par-
ticular tax position should be attained in respect of any person’s specific circumstances.
Copies of this and previous articles are available
n the web or by email at
PLAY IT AGAIN (UNCLE) SAM
escarpment
finance - your wealth
BY J. PETER HODGSON CFA
you r we a l t h