Market Watch Weekly - October 24, 2014
Erik Dekker - Oct 24, 2014
Equity investors have had little opportunity to pad their pockets recently. With abundant noise, including fear over Ebola, tension between Russia and Ukraine, and most recently a shooting at Parliament Hill, markets have been challenging
Equity investors have had little opportunity to pad their pockets recently. With abundant noise, including fear over Ebola, tension between Russia and Ukraine, and most recently a shooting at Parliament Hill, markets have been challenging, to say the least. However, we feel that opportunity is appearing in cyclical stocks, which have started to look attractive once again. With a lower bar now set, and good reason to expect a short and long-term improvement in their spending, companies leveraged to the US consumer may be one such area to focus on.
The S&P 500 and TSX have underrepresented the recent carnage in the market. Mega-cap stocks (blue-chip companies) have held-steady, masking the dramatic decline of between 25 and 50 percent for most stocks. Energy stocks are now up by only a modest 1.7% in 2014, and are the cheapest relative to the TSX since 2004. Growth fears and newly added supply are pushing valuations even lower than they were when oil was trading at less than half of current prices in the depths of the financial crisis. Early last week, Canaccord Genuity Energy Analyst Phil Skolnick highlighted that oil price concerns stemming from the stronger US$ and a view that the U.S. and Saudi Arabia are working together to put financial pressure on Russia are overshadowing how fundamental strength is supporting Canadian heavy oil prices, thus creating a buying opportunity.
It continues to look almost post credit-crisis out there for many stocks and industries, despite no lingering potential for a bank failure or systemic collapse. As we’ve mentioned before, we built up cash reserves in preparation for this pullback. Not to beat a dead horse, but market corrections are indeed ‘natural, normal, and healthy.’ There have been no fewer than 41 corrections in Canada since 1956 when the old ‘300’, the forerunner of today’s Composite, came into existence. With significant, even extreme levels of undervaluation in some TSX sectors, now might be a good time for risk tolerant investors to consider dipping a toe back in. We have been deploying the excess cash as we find opportunities to buy good companies at attractive prices.
We feel that the current environment continues to favour higher equity allocations as their long term return prospects are more attractive than bonds or cash. The equity market is closely correlated to the direction of earnings, which remains positive. The back drop for US equities is perhaps the best we've ever seen. The 10-year bond trades at 50 times earnings with no growth. Stocks on the other hand are trading at 14 times earnings and company earnings are growing. Stocks are poised for a major multiple-expansion, but even without that, the earnings yield is 7% and increasing with the risk free rate pegged at nil. In other words, the equity risk premium is sublime.
Wages are finally rising as bargaining power has shifted to employee from employer; a reflection of the unemployment rate falling to under 6% from over 10%. Oil is the largest tax on the US economy. The price of oil dropping from $110 to $80 will be a huge driver of economic expansion - bigger than Quantitative Easing and will allow the Fed to exit the program gracefully.
Rising oil is inflationary, falling oil is deflationary and thus, interest rates are likely to stay low for a while. With rising wages, falling oil and stable interest rates, consumers will have fuller pockets to buy that new house, car, technology etc. Meanwhile corporate margins are expanding with reduced manufacturing and transport costs. All these factors have culminated in a positive outlook for the remainder of 2014, and into 2015.
For our sports fans, the Vancouver Whitecaps battle the Colorado Rapids in the regular season finale Saturday, with a playoff berth on the line. Win and we’re in. Go Caps!
On another note, for those of you who have children who may not be athletically inclined, but still wish to achieve scholarships to play sports at American universities, there’s still hope. A small private university in Chicago has become the first in the nation to treat video gamers as athletes. Thirty-five students have been granted scholarships to Robert Morris University to play on the varsity team for ‘League of Legends,’ a game in which players control mythical fighters in sci-fi battles. The team will compete against the likes of Harvard and MIT for the North American Collegiate Championships. The Dekker Hewett Group still recommends kids spending some time outdoors, despite this development.
Thank you for your trust.
As always, we welcome your feedback. Have a great weekend.
The Dekker Hewett Group