Picton, president and portfolio manager for Canadian equities at Picton Mahoney Asset Management in Toronto, finds domestic fundamentals aren’t as strong as a rate hike typically implies. As a result, he says, “[The] traditional playbook of playing the BoC hike […] is not to be implemented this time around.”
Despite this summer’s recovery of the Canadian dollar from a “heavily shorted global standpoint,” he also hasn’t moved to increase his positions in the financial or real estate sectors, even following the BoC hike. Picton, whose firm is one of three managers of the Renaissance Canadian Growth Fund, says, “Normally, in a more robust environment with Canadian interest rates going higher, we would be very much favouring financials and housing-related mortgage companies in Canada.”
But given the advanced state of the cycle, he adds, he doesn’t favour a lot of mortgage-weighted holdings. Instead, he’s looking at companies like Air Canada, which are “prime beneficiaries of a higher [Canadian dollar] and oil prices falling. That is a significant position within portfolios.”
Since the end of July, the loonie has started to weaken against the greenback, going from a close of US$0.8043 on July 28 to a close of $0.7913 on August 4 – but that compares to a 2017 low of US$0.7288 on May 8. As of August 7, oil prices were rebounding but still below January’s 2017 highs, with Brent crude nearing $53 and WTI at nearly $50.
Still, there are some benefits to the July rate hike, Picton notes. “We’re in a bit of a cyclical uptick for the Canadian currency and monetary policy, and I think some of that’s necessary.” Further, “We need to get more tightening within the system to squeeze out the heavy reliance we have on real estate in the Canadian landscape,” he says.
A few reasons are “we have consumers that are elevated in their borrowings, prices that are elevated in the housing market and employment trends that are highly elevated in housing,” says Picton.
And that’s why “it makes sense to increase rates to hopefully put a bit of a lid on that. But one has to be careful – if we go too far we do run the risk of a Canadian recession, especially if we’re to see more of a slowdown around the rest of the world.”
What not to buy
Currently, Picton is avoiding names that he refers to as over-owned and “very interest rate-sensitive.” He’s avoiding assets that are “expensive relative to history, or that don’t have maybe as much earnings growth as you would have had in the past. A couple areas that come to mind are the utilities sector and telecom sector.”
Over the past several years both sectors have received high inflows of cash, he says, but “the underlying fundamentals of the actual businesses haven’t really done much to improve, especially if you justify the higher relative valuations that those stocks have.” Going forward, Picton says, “we can see them being used as a source of stability if we get into a rockier climate down the road.”
Picton is cautious on mortgage-related securities. At the Canadian bank level, he says he’s not as concerned when he sees diversified operations, noting, “The ones we like – TD, RBC and BMO, for example – have U.S. operations to offset [risk]. But once you get into mortgage lenders or alt-A mortgage companies, we need a bit of a shake up in the real estate sector before we move back to those things.”