Peter Brieger is chairman and managing director of GlobeInvest Capital Management. His focus is North American large caps.
Precision Drilling (PD TSX)
Target one year price $17.70
This was a past top pick on July 28 at $15.03. Precision Drilling is the largest and one of the lowest cost contract drifters in the Western Canadian Sedimentary Basin (WCSB) and the fourth most active onshore drillers in the U.S. It also has a growing international footprint. We think it will become significantly greater as a result of a recently signed technology and marketing agreement with Schlumberger which we think will add to its overall competitive position.
Royal Bank (RY TSX)
Target 1-year price $86.00
This was a top pick on the Mark 24 show at $64.37. We think that all Canadian banks will provide slow but steady growth going forward with consistent dividend increases. In terms of future business mix, the bank’s target is 50 per cent foreign and 50 per cent domestic. Of that, 50 per cent will come from Investment Management and 50 per cent traditional banking including capital markets. Its more recent quarterly report accentuated what future contributions might be from capital markets and investment management relative to some relatively slower growth in traditional bank lines
Crescent Point Energy (CPG TSX)
Target one year price: $51.40.
This was a top pick on Jan. 27 at $139.36, April 28 at $43.99, May 20 at $43.69 and July 28 at $45.22. As one of the leaders in mainly WCSB oil production (with some U.S.), Crescent Point Energy is accelerating production growth by applying its proven business model. For example, its normal primary recovery rate from a Bakken well is about 15 per cent compared to 20-25 per cent from a conventional well. By applying its 25 stage completion liner and its water flood techniques it has in most cases increased its recovery rate to 20-25 per cent. The long-term target is 40 per cent. From a selection of 750 wells drilled in the past it has applied these techniques successfully on about 40 per cent or 300 wells. They plan to apply these techniques to the remaining 450. On a long-range basis Crescent Point has an inventory of 7,650 wells to which all of which these techniques could be applied. The potential positive leverage to cash flow is enormous.
Past Picks: August 27, 2013
Canfor Corp. (CFP TSX)
Then: $20.30; Now: $25.41 +25.17%; Total return: +25.17%
Crescent Point Energy (CPG TSX)
Then: $38.32; Now: $44.70 +16.65%; Total return: +24.72%
TD Bank (TD TSX) *Stock Split* Feb. 3, 2014: 2 for 1
Then: $87.82; Now: $57.82 +31.68%; Total return: +36.42%
Total return average: +28.77%
If one’s only view of the four main North American markets was their respective charts and rising 50- and 200-day moving averages (“DMA"), one might be forgiven for concluding that all was well in “equity land” for the foreseeable future. However, en route to that possible nirvana, there may be some obstacles to overcome. One of course is seasonal and the other, possibly of a longer duration, is geopolitical.
The former refers to the potentially treacherous September/October period the record for which is mixed. The latter is the Middle East as well as a worry about how events in the Ukraine will end up. At this point no one really knows. But a turn toward a negative outcome (particularly in the Ukraine) may be the trigger for a 5 to 10-per-cent correction that has been bandied about for at least the last several years. As an aside, the several minimal market corrections we have seen during the past year or so (about 3 to 7 per cent) have covered up significantly larger corrections in some specific stocks (i.e.: 5 per cent to more than 15 per cent, in some cases). So arguably the anticipated corrections have taken place but have been confined to individual stocks rather than the markets as a whole.
In my recent commentaries for our clients and BNN viewers, I mentioned the potential for a further significant rise in U.S. corporate earnings per share as the U.S. economy returns to a more normal situation. This could result from the positive leverage resulting from past cost-cutting and a pickup in corporate revenues during the next several years. Another plus for the U.S. economy as well as corporate revenues are the clear indications that U.S. corporations are now starting to divert cash flow from share buybacks to capital spending (Recently reported by Citi).
My past reference to the growth of low-paying jobs so far in this recovery must now be reversed as recent data confirms that the growth of higher paying jobs is the more dominant of the two. Another factor in the potential for growth of the U.S. economy comes from the U.S. housing sector. A recent relaxation of mortgage borrowing standards and a pickup in real income could be the basis for a renewed demand for new homes. According to a J.P. Morgan study, an increase of 250,000 starts creates one million new jobs.
As for potential negatives, inflation in my view will rise – but modestly. Currently the two major influences on the U.S. CPI could come from much higher house prices and medical costs. Declining commodity prices in both the food and energy areas should also help contain any dramatic rises.
As for potential increases in interest rates: it now seems clear that they will also be on the rise. The question is “How will that impact stock markets?” I think it will depend on how fast and to what level they reach, but more importantly I think it will depend on the shape of the yield curve going forward. For example, if one accepts the historic rule that 10 year government bonds must ultimately have a 2 per cent real return and 30 years bonds a 2.75 per cent real return, then based on last Friday’s close the yield on 10 and 30 year Canadian government bonds could rise to 4.08 per cent and 4.80 per cent from 2.08 per cent and 2.60 per cent respectively.
The corresponding yields for 10 and 30 year U.S. treasuries would be 4.36 per cent and 4.75 per cent up from 2.40 per cent and 3.16 per cent respectively. As opined, it depends on how quickly that happens (if indeed it does). The more important aspect is as mentioned: the shape of the yield curve. If we had 2 and 5 years government bonds’ yields rise to the 4 per cent plus levels as they did in late 2006, that flat yield curve would lead sharp market decline as it did in early 2007. In my view it is highly unlikely that the Bank of Canada or the Fed would allow short rates to rise to those levels any time soon.
While remaining alert to and cognizant of potential pitfalls (in the short-term the S&P 500 is “over bought”) we think that the outlook for the next several years remains positive. At this stage, the most ambitious outlook for the S&P 500 based on forward earnings is 18 compared to about 15.20 last Friday. Based on current estimated S&P EPS of $123 and $133 for 2014 and 2015 respectively, potential markets levels rise about 11.40 per cent and 19.90 per cent from last Friday’s levels. That may be too ambitious for now but if U.S. corporate earnings start to accelerate as I think they will, then those levels could well be achieved.
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