Where are Canadian stocks headed? RBC’s bear takes on BMO’s bull in 2018 market standoff

Two prominent strategists are making starkly different forecasts of where Canada’s stock market is headed as a two-month rally stalls.

On the bull side is Brian Belski, chief investment strategist at BMO Capital Markets, who sees the S&P/TSX Composite Index hitting 17,600 by the end of 2018 — about 10 per cent higher than current levels. Taking the bearish view is Matt Barasch, Canadian equity strategist at RBC Capital Markets. Barasch has a 2018 year-end target of 16,300, just 1.8 per cent above Monday’s close.

After struggling through much of 2017 in the red, Canada’s benchmark index is up 4.7 per cent this year, still the third-worst developed market amid a ferocious global rally.

Bull Case

Belski has previously accused Canadian investors of harbouring an “Eeyore complex,” after the morose Winnie-the-Pooh character. He believes strong company fundamentals will eventually override investors’ gloom.

Canadian investors tend to overreact to bad news and then pile into stocks when the outlook starts to brighten, he said.

“In 2016, Canadian investors were positioned for Armageddon and US$15 oil and the banks to go bankrupt; when that didn’t happen, it was a rush to own stocks,” Belski said. “In 2017, it was doubt and rhetoric and what’s going to happen with NAFTA and tariffs and all of a sudden when nothing was happening there’s a fourth-quarter rally.”

He believes Canada is full of strong companies, citing the railways and consumer stocks like Loblaw Cos., Canadian Tire Corp., Dollarama Inc., and Restaurant Brands International Inc. Belski recommends an overweight position in financials, industrials and materials.

Belski has a strong track record of calling the market. In 2016, his year-end level of 15,300 was only 12 points off, and his 16,000 target for 2017 is so far on track — unless a Santa Claus rally gives it another boost.

Bear Case

Barasch, meanwhile, sees Canadian stocks as essentially range-bound for the next year. He lowered his recommendation on the S&P/TSX to market weight from overweight, blaming stretched valuations and a lack of catalysts to drive further multiple expansion.

Possible headwinds include trade threats, central banks unwinding their balance sheets, slowing domestic growth, U.S. tax reform, stagnating oil prices, U.S. election risk, and signs that China is beginning to slow.

“As markets become more fully valued and earnings are recovering, your willingness to look past some of these issues begins to wane,” Barasch said in a phone interview.

Barasch arrived at his 16,300 target by taking his 2018 earnings per share forecast of US$930, a number he calls “fairly aggressive,” and applying a multiple of 17.5 times.

“That would be close to the 90th percentile in terms of valuation historically for the TSX, so it’s not an insignificant multiple,” he said. Barasch recommends an overweight position in real estate, food-staples retail, railroads and life insurers.

Barasch only initiated coverage of the index in May 2016 with a 12-month target for May 2017 of 15,200. It closed out that month not far off at 15,350. He then called for the benchmark to close out 2017 at 16,300 before pushing that target back to 2018.

The biggest risk to his 2018 outlook would be a sudden rise in oil prices, Barasch said. West Texas Intermediate is currently trading at about US$56 a barrel.

“If six months from now oil’s at US$65 and some of these other issues have cleared the deck, then we’re probably going to be wrong, but absent that I think there’s a good chance that 2018’s just going to be a year where you’re going to really have to grind it out for returns.”


In the birthplace of ETFs, active management far outstrips U.S. thanks to this regulatory advantage

Active managers have captured 18 per cent of Canada’s ETF market compared with just 1 per cent in the U.S., the result of a regulatory advantage that lets fund managers keep their strategies close to their vest.

Actively managed exchange-traded funds make up $26 billion (US$20.3 billion) of Canada’s $141 billion ETF market. In the U.S., active ETFs make up only US$39 billion of the US$3.25 trillion market, according to data compiled by Daniel Straus, vice-president of ETF and financial products research at National Bank Financial. 

Unlike traditional ETFs that track indexes, actively managed ETFs allow for individual stock selection, potentially offering higher reward for higher risk. Their strategies run the gamut from ginning up payouts through dividend ETFs, increasing diversification with emerging markets to more exotic strains like the Horizons Active A.I. Global Equity ETF, which is run using artificial intelligence.

The reason for Canada’s embrace of active management is an obscure regulatory advantage. In Canada, which launched the world’s first ETF in 1990, actively managed ETFs are treated the same as mutual funds. This means managers only have to provide quarterly disclosure of their top 25 holdings and semi-annual disclosure of their full portfolio within 60 days of the end of the period. By contrast, all U.S. ETFs have to disclose their holdings daily — a rule that some fund managers are asking the Securities and Exchange Commission to bend.

“That has really hindered active managers in the U.S. from getting into the ETF space,” said Krista Matheson, head of ETFs and structured products at Manulife Investments, which launched its first ETFs earlier this year. “If you’re a true active manager, you don’t want to disclose your holdings on a daily basis.”

The fear that outside investors will mimic the moves of an active manager without investing in their fund — and paying the attendant fees — has also kept the U.S. market small, said Raj Lala, chief executive officer of Toronto-based Evolve Funds Group Inc., which recently launched the Evolve Active Canadian Preferred Share ETF.

“The big managers in the U.S. say there’s not a chance that I’m going to run an active ETF,” Lala said. “One, I’m going to show everybody what I’m holding and what I’m trading, so I’m giving away my secret sauce, and two, it potentially opens up the door for front-running.”

Actively managed funds are growing faster than Canada’s ETF market as a whole. Assets in active funds have grown at an annual rate of 32 per cent for the past five years compared with 20 per cent for all ETFs, according to Straus. 

That’s “faster than any country in the world,” said Steve Hawkins, co-CEO of Horizons ETFs Management Canada Inc., which operates 79 ETFs and has $8.9 billion in assets under management.

The difference between the two countries has created a “regulatory arbitrage” that is encouraging fund managers from around the world to bring active strategies to Canada first, said Hawkins. Horizons offers 32 active ETFs with focuses ranging from Canadian municipal bonds to natural gas.

Canada’s regulations have allowed Horizons to create products that look like mutual funds, and “package them in a more efficient ETF wrapper,” said Hawkins.

“The rest of the world still has a lot to catch up to with respect to the foresight of our regulators in allowing us to launch products like this,” he said. “We think is a very good thing for the Canadian marketplace as a whole.”

–With assistance from Carolina Wilson


Hudson’s Bay investors want debt reduction, payouts from real estate proceeds

TORONTO — As Hudson’s Bay Co steps up the pace of extracting value from its US$5 billion property portfolio, the department store chain’s shareholders want it to reduce debt, return cash to them and not invest the proceeds in traditional retail operations.

Hudson’s Bay is not new to selling real estate, but its actions are under greater scrutiny amid rising tensions between the company and activist hedge fund Land & Buildings, which says it holds about 5 per cent of the company.

The fund wants the owner of Saks Fifth Avenue and Lord & Taylor to sell or convert stores to alternate uses and transform itself into a real estate play. It values HBC’s real estate at about $35 a share, three times more than the company’s current level.

“The perception, and in some cases, the reality, is that (Amazon.com Inc) is speeding bricks and mortar retailers into submission,” said Jonathan Norwood of Mackenzie Investments, HBC’s eighth-biggest shareholder.

“If they sell the real estate, we want to see the money used to reduce debt and returned to shareholders,” added Norwood, who co-leads Mackenzie’s value-focused Cundill team. “We don’t want it going to revitalize or grow the retail operations.”

HBC is exploring the sale of its Vancouver flagship store, estimated at about $800 million (US$628.4 million), after selling its Lord & Taylor property in Manhattan for US$850 million last month.

Selling properties will further expose HBC to a brutal retail market but has not deterred the company from opening new stores in the Netherlands this year.

“It’s hard for an investor to get excited about new store openings when existing stores are on rocky ground,” said Joshua Varghese, portfolio manager at CI Investments, HBC’s sixth-largest shareholder.

The company should “seriously consider” a 3 billion euro offer from Signa Holdings for its German stores, Varghese said, noting HBC shares are unlikely to see significant gains without clarity on the company’s strategy.

An HBC spokeswoman declined to say whether the company has identified areas to deploy the proceeds from any future asset sales. It will use funds from the Lord & Taylor sale to pay down debt, which totalled $3.4 billion as of July 29, excluding its two joint ventures.

HBC’s net debt was 4.7 times earnings before interest, taxes, depreciation and amortization after the Lord & Taylor sale, compared with an industry average of 2, according to Royal Bank of Canada.

“If Richard (Baker, HBC’s executive chairman) sells the Vancouver store, he’ll probably pay off debt on the operating company,” said an HBC shareholder who declined to be identified. “I don’t think they’ll sell all the stores; they’re monetizing individual stores where demand is good.”


© Thomson Reuters 2017

With $18.8B deal, Brookfield doubles down on the mall

Brookfield Property Partners L.P.’s $18.8-billion bid for the portion U.S. mall operator GGP Inc. that it doesn’t already own is underscoring the firm’s belief that brick-and-mortar retail isn’t dead — it may just need to broaden its horizons.

Toronto-based Brookfield, the real estate arm of Brookfield Asset Management Inc., already owns 34 per cent of GGP. It confirmed Monday that it is offering to buy the remaining 66 per cent of Chicago-based company for US$23 per share.

“We are excited about the opportunity to leverage our expertise to grow, transform or reposition GGP’s shopping centers, creating long-term value in a way that would not otherwise be possible,” said Brian Kingston, chief executive of Brookfield Property Group, in a release.

Brookfield has recently expressed optimism about redeveloping or revitalizing retail real estate, bucking the conventional wisdom that malls are in decline and online shopping is on the rise. Earlier this month, Brookfield Property Partners reported third-quarter occupancy for its retail portfolio was up 80 basis points, to 95.4 per cent.

“These positive results demonstrate that well-located, high-quality retail real estate in the U.S. continues to perform well, despite negative perception in the public markets,” Kingston wrote in a Nov. 2 letter to unit holders. “While some retailers continue to face significant challenges in growing their businesses, those retailers focused on the intersection of bricks and mortar retail with online sales channels continue to expand and grow.”

GGP, which prides itself on owning “high-quality” retail properties in the U.S., including several locations on New York City’s Fifth Avenue, seems to fit that bill.

“GGP is not a bunch of third-tier malls that are getting destroyed by the internet,” said Mark Rothschild, real estate analyst with Canaccord Genuity. “The malls are evolving, but they’re absolutely not disappearing.”

Rothschild said the company also aims to offer “unique experiences” at its malls, giving customers a reason to go there beyond shopping.

“There are malls that no matter what happens online, that real estate is still worth a lot of money and people will go to,” Rothschild said. “And there will be things that the landlords do to make that a fun place to be, whether it’s eating, whether it’s other activities, whether it’s shopping.”

Shares of Brookfield Property Partners fell 4.47 per cent in Toronto on Monday, to $28.66. The company’s stock price has declined 2.28 per cent for the year. Meanwhile, shares of GGP jumped 8.33 per cent, closing at US$24.05 Monday, down 3.72 per cent for 2017.

GGP said in a release that its board had struck a special committee of independent directors to review and consider Brookfield’s proposal.

“There can be no assurance that a definitive offer relating to the proposal will be made, that a definitive agreement relating to the proposal or any other transaction will be entered into by the company, or that any transaction will be consummated,” GGP added.

But, if the deal does go through, Brookfield said it would create “one of the largest listed property companies in the world, with an ownership interest in almost $100 billion of premier real estate assets globally and annual net operating income of approximately $5 billion.”

Brookfield bought into GGP in 2010, helping the latter emerge from bankruptcy with a $2.5-billion investment that was made in return for approximately 26 per cent of the company. Hedge fund manager Bill Ackman’s Pershing Square also invested at the time, putting up $1.1-billion in exchange for an 11-per-cent stake, according to a release.

The latest GGP deal could give Brookfield another way to double down on retail, or to repurpose the valuable space it may occupy.

“We continue to acquire big-box anchor spaces in our malls and reposition them,” Kingston wrote in his letter to unit holders, prior to the deal. “We can earn excellent returns doing this and it is one of the best opportunities in U.S. retail today.”

Twitter: @geoffzochodne

Supergirl actor’s claim that Chipotle food almost killed him sends shares on roller-coaster ride

Chipotle Mexican Grill Inc. said there’s no connection between the company and an illness suffered by Supergirl actor Jeremy Jordan, who blamed the burrito chain for making him severely sick.

“There is not a link and there are no other reports of illness at the restaurant,” Quinn Kelsey, a spokeswoman for the Denver-based company, said in an email. The location — in Houston — hasn’t been closed, she said.

The incident threatens to renew concerns about food safety at Chipotle, which has struggled to bounce back from an E. coli crisis in 2015 that sickened customers. Jordan said last week that he was hospitalized after eating at the chain.

The actor, who plays Winn Schott on “Supergirl,” posted an Instagram story on Thursday from his hospital bed, saying that “the food did not agree with me and I almost died,” according to People.

The celebrity’s complaint sent Chipotle shares tumbling in early trading on Monday, extending a rout this year. Chipotle’s denial of a link prompted a brief recovery for the stock, but the rebound was quickly erased in regular trading.

The shares fell as much as 5.9 per cent to US$263, bringing them to the lowest level in almost five years. They had already declined 26 per cent in 2017 through the end of last week.

The company said on Monday morning that it had reached the actor to determine where and when he ate, Kelsey said.

“We were able to confirm that there were no reports of illness, all employees were healthy, and that all food protocols were followed and logged,” she said. “We take all claims seriously, but we can’t confirm any link to Chipotle given the details he shared with us.”

The company had begun to restore its reputation in the past year, but a norovirus incident in Virginia and a viral video of mice at a Dallas location sparked a fresh round of negative headlines.

Chipotle also suffered a data breach earlier this year, an incident that hurt its earnings and contributed to another stock slump. This year’s hurricanes rocked Chipotle as well: It had 425 restaurants in the direct path of the storms.


Bank rescue plan threatens to squeeze $95 billion corner of Canada’s bond market

New rules to protect taxpayers from bank failures may push investors out of a $95 billion (US$75 billion) corner of Canada’s corporate bond market, reducing liquidity and raising borrowing costs.

Under a regime set to take effect in 2018, short-term bank-deposit notes typically sold to institutional investors will gradually be replaced by senior “bail-in” debt that can convert to equity in the event of a bank failure. The new instruments may be off limits to money-market investors who aren’t allowed to hold securities that risk being converted to equity, some analysts and money managers say.

The changes could cause friction in the $310 billion money market that greases the wheels of corporate finance. Short-term investors scoop up deposit notes with less than a year left to maturity as longer-term investors sell. That helps keep the market liquid, allows banks to borrow at low rates and offers investors access to safe bonds that yield more than short-term government debt.

“What we don’t know is if there is going to be an impact to bank funding costs because there is not a wall of money market buying at one year,” according to Kris Somers, a credit analyst at BMO Capital Markets who follows Canadian banks.

The federal government and bank regulator are expected to release final guidelines for the bail-in regime before the end of the year, including how much debt and capital banks will need to hold to satisfy their total loss-absorbing capacity requirement, also known as the TLAC ratio. The framework is part of a global effort to prevent a repeat of the 2008 financial crisis, which saw taxpayers fund massive bailouts of banks. The potential wrinkle for Canadian money-market investors is due to an interpretation of existing securities law.

‘Fewer Options’

The draft rules say unsecured debt with a term of at least 400 days will be eligible for bail-in and that a security must have at least 365 remaining days to maturity to count toward a bank’s TLAC ratio. The TLAC ratio must be 21.5 per cent of risk-weighted assets by Nov. 1, 2021. Currently the big five Canadian banks have an average TLAC ratio of 15 per cent, according to Himanshu Bakshi, a Bloomberg Intelligence credit analyst.

About $18.6 billion of existing deposit notes mature in the first half of 2018, according to a RBC Capital Markets report. If banks don’t issue deposit notes to replace them before the bail-in guidelines are finalized, they will be replaced by senior bail-in debt. The average spread on a five-year deposit note is about 71 basis points over government debt, according to RBC.

“We’re going to have fewer options to add yield to the portfolio,” Walter Posiewko, a money-market fund manager at RBC Global Asset Management, said by phone from Toronto. The fund likely won’t purchase the new senior bail-in debt because of the lack of clarity around securities regulation and liquidity concerns, choosing instead to buy other short-term bank debt such as banker’s acceptance and bearer deposit notes, he said.

No Prohibition

The Office of the Superintendent of Financial Institutions, Canada’s bank regulator, has no intention of amending its guidelines to address the question, spokeswoman Annik Faucher said in an email. Current guidelines don’t prohibit investors from purchasing the debt, she said.

The Ontario Securities Commission and the Canadian Securities Administrators, an umbrella organization of provincial regulators, declined to comment.

The proposed bail-in rules are not intended or expected to result in significant changes to banks’ funding structures, including which investors buy the debt, Jocelyn Sweet, deputy spokesperson for Finance Canada, said in an email. The regulation does not prohibit particular types of investors from buying bail-in debt, she said.

Clarify Rules

Securities regulators will likely need to clarify whether rules governing money-market funds prohibit them from investing in bail-in bonds, even if they aren’t the same as traditional convertible debt, and the likelihood of a Canadian bank needing rescue is very low, Kashif Zaman, a partner in the financial services practice of Osler, Hoskin & Harcourt said by phone from Toronto.

“It’s really up to securities regulators to acknowledge or recognize whether they need to make an exception for this,” he said.



The old GE is dead: $100 billion wipeout heralds reckoning for an American icon

NEW YORK — Few under the age of 30 might remember, but General Electric Co. was once a model of corporate greatness.

Back in 1999, when Steve Jobs was still fiddling with iMacs, Fortune magazine proclaimed Jack Welch, then GE’s chief executive officer, the best manager of the 20th Century.

Few people — of whatever age — would lavish such praise on the manufacturer these days.

GE, that paragon of modern management, has fallen so far that it’s scarcely recognizable. The old GE is dead, undone by an unfortunate mix of missteps and bad luck. The new one now confronts some of the most daunting challenges in the company’s 125-year history.

The numbers tell the story: This year alone, roughly US$100 billion has been wiped off GE’s stock market value. With mounting cash-flow problems at the once-mighty company, even the dividend is at risk of being cut. The last time GE chopped the payout was in the Great Recession — and before that, the Great Depression.

And yet the hit to the collective psyche of generations of investors and managers is incalculable. For decades, GE-think infiltrated boardrooms around the world. Six Sigma quality control, strict performance metrics, management boot camps — all that and more informed the MBAs of the 1970s, ’80s, ’90s and into this century. GE, in turn, seeded corporate America with its executives.

Anxious Investors

Now, John Flannery, GE’s new CEO, is struggling to win back the trust of anxious investors. He’s set to detail his turnaround plans on Monday — and has said he’ll consider every option.

“There’s nothing less than the fate of a once great, great company on the line,” said Thomas O’Boyle, the author of “At Any Cost: Jack Welch, General Electric, and the Pursuit of Profit.” “Some of the fundamental notions about its status as a conglomerate and whether it can succeed in a world of increasing complexity are really being challenged right now.”

In hindsight, the seeds of this struggle were planted decades ago. Welch expanded and reshaped GE with hundreds of acquisitions and demanded every GE unit be No. 1 or No. 2 in its industry. He also culled low-performers ruthlessly, earning the nickname Neutron Jack. By the time he retired, in 2001, GE’s market value had soared from less than US$20 billion to almost US$400 billion.

But all that manoeuvring, plus GE’s increasingly complex financial operations, obscured the underlying performance and put the company in peril during the 2008 financial crisis. Welch’s successor, Jeffrey Immelt, soon embarked on a plan to undo much of the House that Jack Built. He would sell NBC and most of the finance operations — two of the businesses that defined Welch’s tenure — along with units such as plastics and home-appliances.

The moves narrowed GE’s focus, yet it remains a collection of somewhat disparate manufacturing businesses, ranging from jet engines to oilfield equipment.

Out of Favour

Unfortunately for GE, that industrial conglomerate model has fallen sharply out of favour on Wall Street. And the rise of activist investors such as Nelson Peltz has encouraged companies to try to boost their stock prices however they can, rather than focus on the long term. GE recently welcomed one of Peltz’s partners at Trian Fund Management to the board.

“The reckoning had to come,” said Jack De Gan, chief investment officer of Harbor Advisory, which has been a GE shareholder for more than 20 years before selling most of the shares in the past few weeks.

GE’s leaders have long defended the multi-business strategy by pointing to the benefits of sharing technology across product lines — jet engines, for instance, have a lot in common with gas turbines. In an interview with Bloomberg in June, Flannery dismissed concerns about conglomerates, saying investors care more about outcomes.

“They want growth, they want visibility, they want predictability, they want margin rate,” Flannery said. “And there are a multitude of models to produce that.”

US$20 Billion

The new CEO has already said he’ll divest at least US$20 billion of assets. He’s coming under pressure to do even more.

“Anything less than a sweeping plan to ‘de-conglomerate’ the portfolio would be viewed as disappointing,” Deane Dray, an analyst with RBC Capital Markets, said this week in a note to clients. The potential moves include unloading its transportation, oil, health-care and lighting operations.

To be sure, GE’s issues run deeper than the composition of the company. One of the Boston-based company’s biggest divisions, power-generation, is in the early stages of a deep market slump — just two years after bulking up with the US$10 billion acquisition of Alstom SA’s energy business. GE’s cash flow is light, potentially putting the dividend in jeopardy and driving investors away from the stock.

Flannery has spoken of the need to change GE’s culture and instill a sense of accountability. He’s reined in excessive spending — on corporate cars and planes, on the new Boston headquarters — and replaced top executives.

But the sudden changes, combined with Flannery’s relative lack of public reassurances, have spooked investors. In the days after Flannery’s first quarterly earnings as CEO, when he called GE’s performance “completely unacceptable,” the stock fell and fell. And fell some more, closing at the lowest level in five years on Nov. 2.

The shares slid less than 1 per cent to US$19.99 on Thursday, bringing the 2017 loss to 37 per cent.

“You think about a company like Kodak. Will GE become that?” said Vijay Govindarajan, a professor at Dartmouth University’s Tuck School of Business who served as GE’s professor-in-residence in 2008 and 2009.

Some investors may be throwing in the towel, but Govindarajan isn’t giving up. “I will put my bet that GE will weather this and come back,” he said.


Canadian penny stock West High Yield dives 83% after $750 million deal vaporizes

A Canadian penny stock plunged 83 per cent in the first day of trading after its US$750-million mining deal collapsed, bringing an end to a wild ride that saw its shares surge almost 1,000 per cent in a single day.

West High Yield (W.H.Y.) Resources Ltd. dropped to 34 cents at 10:20 a.m. in Toronto after resuming trading for the first time since Oct. 5. That was the day the tiny Calgary-based explorer announced what would have been one of the year’s biggest mining deals — the sale of its main magnesium assets to an obscure buyer, Gryphon Enterprises LLC.

The deal fell through after Gryphon failed to come up with a deposit of less than 1 per cent of the transaction value, or US$500,000, by a Nov. 6 deadline. The collapse of the deal spelled the end of the brief but extraordinary rally that had propelled a company with no revenue to a market value of $114 million (US$90 million). Trading under the ticker WHY, its stock jumped to as high as $3.80, from just 36 cents the previous day, and ended the session at $2, sparking a review by regulators in Alberta.

From the beginning, however, there were questions about the deal. It wasn’t clear why Gryphon, which doesn’t have a website, was prepared to pay US$750 million for West High Yield’s assets in British Columbia, when the whole company was worth only US$16 million. According to the purchase and sale agreement, Gryphon’s chief executive officer used an AOL email address and the firm was based at a residential house built in 1992 in Swanton, Maryland.

West High Yield had continued to trade on Oct. 5 as more red flags appeared and volume soared. That sparked criticism from some that the regulators should have stepped in earlier to take control of the situation. Trading was halted on Oct. 6.

The Investment Industry Regulatory Organization of Canada has said it won’t reverse trades from that day because the announcement “did not contain information which was either misstated or inaccurate.” The Alberta Securities Commission has declined to comment on whether it’s still reviewing the company and the deal.

–With assistance from Danielle Bochove