Brexit and the U.S. election outcome, two big surprises in 2016, are wake-up calls for 2017.
“Geopolitical risk has to be monitored,” says Konstantin Boehmer, a vice-president and portfolio manager at Mackenzie Investments in Toronto. Instead of being relegated to fringe countries, extreme political views are now mainstream, he says.
For proof, look no further than the U.S. president-elect or the rise of political parties like the Alternative for Germany.
A growing unease with immigration and globalization means more distress and isolationism. Kara Lilly, an investment strategist at Mawer Investment Management in Calgary, says the resulting protectionism is inflationary and bad for productivity and growth. That bodes well for companies like Intertek, a U.K.-based testing, inspection and certification business, which Mawer holds. In such a world, “people want to test and certify things going over borders,” says Lilly.
Som Seif, president and CEO of Purpose Investments in Toronto, urges caution because of Donald Trump’s uncertain policies. For instance, “if the Trump administration starts driving trade rhetoric against China, the markets may respond poorly.”
That uncertainty means volatility is the one thing to count on for 2017, says Renato Anzovino, vice-president and portfolio manager at Heward Investment Management in Montreal.
Seif says the decline of the pound in Brexit’s wake makes Britain a “more attractive exporter into Europe broadly, which will make the rest of Europe less competitive.”
For opportunity, he looks to emerging markets. “People are going to look back and say they’re glad they allocated more to emerging markets in the next twelve months.”
“Stronger global growth, reflationary central bank policies, lots of liquidity in the backdrop—this all makes way for our positive outlook on equities versus fixed income,” says Candice Bangsund, vice-president and portfolio manager at Fiera Capital, who likes energy, materials and financials for 2017. But “our bigger call is on the regional basis,” she says: Fiera’s overweight Canada and emerging markets, which are performing well thanks to rebounding oil prices.
David Stonehouse, vice-president and portfolio manager at AGF in Toronto, likes financials such as J.P. Morgan, Manulife and ING Group, which are “in much stronger shape than previously, have relatively undemanding valuations compared to the market overall and will benefit from a steepening yield curve.” Attractive valuations also make him constructive on healthcare; he bought pharmaceutical Bristol-Myers Squibb after a disappointing drug trial. While he bought in the low $60s and into the $50s (as of press time, the stock was almost US$57 on the NYSE), he says the name is a good long-term prospect.
Anzovino continues to hold Walgreens and Jean Coutu, citing increased drug demand from an aging population. He added Canadian REIT Chartwell Retirement Residences, which he says is well-priced because of expected inflation and a U.S. rate hike.
With Trump’s support for Keystone, Anzovino added to his position in TransCanada Corporation after the U.S. election, though he expects its share price to gain regardless of whether the pipeline gets built.
Other solid stocks in his portfolio are transport and courier companies TransForce and Germany’s Deutsche Post, the latter being the largest such company operating in China and emerging markets; others are tech companies Cisco and OpenText, which provide IT services and manage digital content, respectively.
Look for deals on strong dividend-paying stocks, as other investors shy away on expectations of higher interest rates and inflation. Emera, a Canadian utilities company trading at 20% below its value and which acquired TECO Energy in 2015, has good growth potential for years to come, says Anzovino.
For bonds, a bearish approach will continue, says Stonehouse. But he expects an upcoming bond buying opportunity in 2017 associated with a short-lived peak in inflation “because of easy year-over-year comparisons, especially with the likes of commodities such as oil.”
Boehmer looks to leveraged loans in the U.S. because of their increased flows, floating interest rate and superior capital structure relative to high-yield bonds at this point in the credit cycle. Further, he expects LIBOR to continue rising in 2017, making U.S. loans all the more attractive. He owns several names, including Dell International, Uber, Prospect Medical and Chobani.
Stonehouse is overweight American large-cap banks, and takes advantage of cheap European banks. He holds UBS contingent convertible bonds, saying they’re from “one of the strongest financial institutions in Europe.”
He also likes Canada’s Just Energy convertible bonds, because the retailer has improving financials and greater free cash flow. It recently completed financing to pay debt, and he sees its negative subscriber growth as a plus, because the company is “resetting to a more lucrative customer base.”
In tech, Stonehouse holds convertible bonds in cloud software company ServiceNow. In energy, he holds Encana bonds. “We’re not secularly bullish on oil, but we still think it’s got room to rebound from the massive declines of ’14 and ’15.”
Despite low yields, 10-year bonds from New Zealand (yielding 3.05%), Australia (2.70%) and Norway (1.60%) offer good value relative to the underlying credit, says James Redpath, a portfolio manager at Mawer in Calgary. However, as small open economies reliant on commodities, they are higher risk compared to more diversified sovereign issuers, he says.
Boehmer says inflation-linked bonds are relatively attractive, because he expects both headline and core inflation to increase over the next few quarters. That’s courtesy of rising energy prices, which ultimately affect both, he says, noting core inflation still includes oil-related expenses, like embedded transportation. He likes 30-year TIPS in the U.S. and 30-year real return bonds in Canada. “The 30-year break-evens in the U.S. are […] about 2.1%; in Canada, 1.8%,” he says. “So there’s not much inflation priced in.”
He also likes five-year covered bonds in Denmark, which have strong creditor protection. In Denmark, “you’re liable for life for your mortgage, and if you default on your mortgage, you have to leave your home within a couple of months or so.” A five-year bond offers a yield to maturity of about 20 basis points in a country with negative interest rates.
Boehmer hedges the krone back into Canadian dollars, receiving the interest rate differential plus cross-currency basis points, a total of about 1.5%.The result: “A five-year investment in a very safe asset class at 1.7% yield, and that compares extremely favourable to anything in Canada,” he says.
Boehmer shorts Swedish 10-year notes, thinking Sweden will adopt a more normal monetary policy outlook soon, instead of erroneously mirroring the ECB. In emerging markets, Chile is attractive as one of the richest governments in the world, he says, with a central bank that has room to manoeuver.
Stonehouse holds bonds from Peru and Mexico, and may add more South and Central American bonds, such as Brazil. “We need to get a better sense of just how protectionist Trump wants to be,” Stonehouse says, referring to inherent risk for Mexico.
Gold and oil
Stonehouse is bullish on gold over the medium term only, viewing it as a hedge against currency (and thus geopolitical risk) and action by central banks. He holds Agnico Eagle Mines (“a high-quality company with good execution”) and Newmont Mining convertible bonds (yielding 1.625%; “a nice, easy, liquid way to participate in gold”).
Anticipating higher inflation and interest rates, Bangsund’s neutral on gold. But she’s bullish on oil, citing her call for Canada and emerging markets.
Reflections on 2016
After Brexit, “we had to rethink our outlook on the European economy,” says Candice Bangsund, vice-president and portfolio manager at Fiera Capital.
“We were overweight European equity going into the vote,” but afterward, she says, “the central bank backdrop became increasingly accommodative, which is actually supportive of the global economy and risky assets like equities.”
In the end, Fiera added to its equity exposure, but with a focus on Canada and emerging markets. That served her well after Donald Trump’s win increased inflation expectations on his fiscal and protectionist policies. Further, “the pro-growth backdrop endorses our preference for cyclically biased, commodity-levered regions of the world such as Canada and the emerging markets,” she says.
Som Seif, president and CEO of Purpose Investments in Toronto, predicted value was the place to be in 2016. “That played out extremely well,” he says. According to the S&P Dow Jones Indices, value stocks outperformed growth 8% to 4%. With value stocks being cheap relative to growth and momentum stocks, look for more value opportunities in 2017.