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April Newsletter - Only Eat the Green Smarties

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Who doesn’t like smarties? One handful is as good as the next (i.e the taste of them all is highly correlated). What if they changed them so only the green and blue ones tasted good and the others tasted terrible (i.e. the taste of the green and yellow became highly uncorrelated)? What would you do? Most likely you would become a bit more choosey about picking out the good ones and tossing the bad ones. Zoe says more like Jelly Bellies ;o)

 

Essentially, that seems to be where we are in the equity markets, at least here in North America. There is good news and bad news.

 

First the Bad News

 

Stocks and sector correlations are at their lowest level in 15 years. Normally, if the broad market goes up, either TSX or S&P 500, most of the underlying sectors go up. Further, if a sector goes up, most of the underlying stocks go up. In a strong breeze, even turkeys can fly kind of stuff. This is when there is a good deal of correlation among the sectors and their underlying stocks or companies.

 

What we have now is a market where there is very little correlation. The broader markets are up but underneath that some sectors are up and some are down. Further, at the sector level, some stocks are up and some are down. Let’s look at some examples.

 

First for context, at time of writing (April 25, 2017) the TSX is up 3.0% year to date. The Dow Jones Industrial Index is up 6.3%. Both as reported on Thomson One quote service.

 

In Canada for example the energy sub-index is down -9.70% whereas the financials are up about 3.60%. The U.S. is similar. These again as quoted by Thomson One, April 25, 2017.

 

Underlying the sectors are individual company stocks which are again uncorrelated, i.e.  some are green and some are yellow?

 

Taking some of the BMO research from their Red Book of April 2017, they have the following opinions even within the same sectors.

 

Consumer Discretionary

Company                 12-month target price

Wal-Mart                  -9%

Costco                     +9%

 

Healthcare

Company                 12-month target price

Bristol-Myers            -14%

Merck                       +14%

 

Financials

Company                 12-month target price

Wells Fargo              -7%

Citigroup                  +8%

 

Now. Just as a word of caution. Analysts are all really smart but to make it perfectly clear, even really smart people can be wrong. It takes two sides to make a market. For example. In the same BMO research report, the analyst, Kelly Bania said at the time that her best bet was David’s Tea, DTEA. It was trading at $7.35 and she concluded that the actual one year target price was $9.00 for an estimated gain of 22.5%. Shortly after, David’s Tea came out with a report showing lower than expected earnings and problems with inventory so the stock price dove to $6.35 and Kelly has revised her target to $5.50. Ooops.

 

The point here is that it appears to be a stock pickers market and active management has the opportunity to outperform passive ETFs. To substantiate the point, at time of writing the Dow is up 6.3% and the TSX up 3.0% year to date. Our philosophy, especially in times like these when the correlation is lower, is to pick the best in class mutual fund, active manager who we believe can outperform the index. For example, as reported by Morningstar Advisor at time of writing the BMO US Equity fund is up 6.79% year to date and the Mawer Canadian Equity fund is up 3.80% so in this kind of market active management wins. (please see below for the 1,3,5 and 10 year returns of both of these funds). For stocks, we are looking at the best in class for a given sector, for example, Bank of America for US Financials.

 

Now the Good News

 

The world at the moment seems fixated on Trump and his policies. We get comments every day to the tune of “OMG, with Trump in charge the markets are going to hell in a handbasket”. A natural reaction, but an emotional one not based in fact. The truth is that interest rates are still at historic lows. Inflation is sub 2% and unemployment is virtually zero. These are all success factors for the US economy and therefore the stock market. Whatever Trump does in the short term will take a long time to affect the markets. The Titanic takes a long time to change course.

 

The other fact is that the markets now seem to absorb shocks much more quickly than they used to. The US has tossed the “Mother Of All Bombs” at Afghanistan and the UK is about to leave the EU. Ten years ago, either of these events would have rattled the markets terribly and either or both of the Dow and TSX would have been down 400 points or more. Today, these events, although tragic, have almost no effect on the global equity markets. Investors are far more resilient now than in past. What this means to us as investors is, in as much as the media want to create pandemonium, investors are calmer, or let’s say smarter about these things than they once were.

 

There will be a time to become more defensive, our position presently is that it’s not here quite yet.

 

As always, if you want to chat or get more information, don’t hesitate to call or e-mail us.

 

Additional return information on the mutual funds mentioned above as of April 26, 2017. All returns in CAD$

                                     YTD          1 yr           3 yr           5yr          10yr

BMO US Equity            8.17%       22.8%       15.81%    17.90%      6.60%

S&P 500                       6.79%       20.77%     14.24%    16.59%      6.68%

+/-                                 .71%         2.03%       1.58%      1.31%        -.08%

 

                                     YTD          1 yr           3 yr           5yr          10yr

Mawer Cdn Equity        3.80%       16.08%     9.43%      13.30%    7.85%

TSX                               2.92%       15.01%    5.18%       8.60%      3.88%

+/-                                 .88%          1.07%      4.25%      4.70%       4.26%

 

Disclaimer:This publication is solely the work of Scott Blair for the private information of his clients. Although the author is a Manulife Securities Advisor, he is not a financial analyst at Manulife Securities Incorporated or Manulife Securities Insurance Inc. (“Manulife Securities”). This is not an official publication of Manulife Securities. The views, opinions and recommendations are those of the author alone and they may not necessarily be those of Manulife Securities. This publication is not an offer to sell or a solicitation of an offer to buy any securities. This publication is not meant to provide legal, accounting or account advice. As each situation is different, you should seek advice based on your specific circumstances. Please call to arrange for an appointment. The information contained herein was obtained from sources believed to be reliable; however, no representation or warranty, express or implied, is made by the writer, Manulife Securities or any other person as to its accuracy, completeness or correctness