Views of Gordon Higgins CPA CA, MBA, CFA This and prior newsletters are available at www.higginsinvestment.com The Markets March Change in Month Year To- Date S&P TSX 15367-0.5% 5.1% S&P 500 2641 2.7% 1.2% Dow 30 24103-3.7% -2.5% Oil $64.94 5.3% 7.5% Gold $1327 0.7% 1.4% This was another in a series of months with increased volatility. In February, the Dow had its biggest point decrease ever which was followed by a significant rally. The Dow had its biggest one day point gain in March since 2008, a jump of 2.7%. This was after the Dow had suffered its worst week in years. All these gyrations were due to the rising spectre of a trade war between the US and China. Trump began by indicating he would put tariffs on $50 billion of Chinese exports. When China did not respond for a few days the markets rallied. The Chinese were merely biding their time and they announced retaliatory tariffs on US goods the next week. Some traders believe the recent decline broke some patterns on charts which will lead to continued weakness. Others offered the market had risen too high too fast so was due for a decline. Either way it was a volatile month. The Canadian market outperformed the US market for the first time in a while. The fact Trump turned his focus from unfair Canadian trade to China s trade allowed our market to pause while the US market declined on fears of a trade war. Canadian Growth stocks had a positive month but so called value stocks declined by 2% in the month. A rebound in the price of Gold and Oil led the Energy and Materials sectors to positive returns; both are still negative for the quarter. The threat of a trade war led bond investors to worry about slower economic growth which in turn led to a belief the central banks would not have to raise rates, therefore lower interest rates led to a rally in the bond market. Lower interest rates contributed to a rally in Real Estate and Utility stocks. The chart on the next page presents the performance of the S&P 500 and the S&P TSX over the past 3 months. HIGGINSINVESTMENT.COM PAGE 1
3 Month Performance S&P 500 and TSX TSX, S&P 500 source googlefinance Economic Indicators 1. US Economy Last month we reported about a decline in Durable goods orders and how it might be a harbinger of a weaker economy. The most recently reported durable goods orders reversed the decline experienced last month. Durable goods rose 3.1% in February which crushed the analyst s expectations of 1.8%. Core orders rose 1.8% to reverse a decline in each of the past two months. Year-over-year core orders rose 8% which is close to a six year high. Orders are a good indicator of future sales activity. Industrial production rose 1.1% in February. This is the largest increase since the fall of 2017. Manufacturing rose 1.2% and Mining grew by 4.3%. Oil and gas production leapt 12% over the same month last year due to a combination of pricing and production levels. Increased production led to higher levels of capacity utilization. Capacity utilization rose to 78.1% which is close to the 80% level that often leads to inflation in production inputs, including labour. Preliminary indicators lead analysts to believe March s production is likely to exceed February s strong numbers. HIGGINSINVESTMENT.COM PAGE 2
2. US Consumer The US consumer looks poised to contribute to continued economic growth. Personal income grew by $67.3 billion or 0.4% in February. The consumer spent $27.7 billion of the increased income. Personal income has been on a growth trajectory over the past few years as it increased by 2.4% in 2016, 3.1% in 2017 and, if February is a good indicator, higher levels are expected in 2018. The University of Michigan s consumer sentiment index hit levels not seen since 2004. The index exceeded both the levels in January and analysts expectations for no change. Interestingly, the growth in positive sentiment was concentrated in the population that are in the bottom third of income earners. One positive is the bottom third are likely to spend their improved income while they have a small portion of the wealth to spend. Consumers may be more optimistic as the prospect for employment improves. February payrolls grew by 313,000 jobs. Not only is this exceptional growth but the previous two months were revised upward by 54,000. This was the biggest increase since the summer of 2016. Despite the increase in employment the unemployment rate did not decline because the improved prospects for employment led more people to look for work. Not only were more people working but the average number of hours worked per week rose by more than 1 hour over the January level. The percentage of working age Americans with jobs rose to 60.4% compared to 60.1% in January. As companies hired the number of layoffs also decline to hit the lowest level in almost 50 years. 3. Canada After strong growth in 2017 the Canadian economy began to slow in 2018. Real GDP, a key measure of the size of an economy, declined 0.1% in January after a 0.2% increase in December. Most of the decline was attributable to lower production from the oil sands in Alberta. Maintenance at key facilities led to a 7% decline in non-conventional oil production. This is not likely to impact the economy in future months and should help with growth later in the year. In the chart on the next page it appears that real GDP is reaching a plateau. A slowdown in housing sales in key centres including Toronto and Vancouver led to lower profits by real estate agents and lawyers in those cities. Manufacturing resumed its growth trajectory. Manufacturing rose 0.7% in January. Manufacturing has increased in 3 of the last 4 months. HIGGINSINVESTMENT.COM PAGE 3
There was a modest improvement in employment in February. Employment grew by 15,000 over January and by 283,000 over the same month last year. The entire gain was in full-time employment. These changes are in the face of increases to the minimum wage in Ontario and Alberta. The number of people employed in retail declined by 22,000 in February. However the number of people employed in retail was 36,000 higher than a year ago, despite the drag caused by the closing of Sears and the higher minimum wage. The chart below shows the steady decline in the unemployment rate over the past two years. The unemployment rate for core aged, defined as between 25 and 64, was 4.9%. The core rate was 5.5% a year ago. 4. China The first paragraph is an excerpt from the National Bureau of Statistics of China. The summary is thanks to the communist leaders the economy continues to grow. The paragraphs that follow will detail the areas of strength. HIGGINSINVESTMENT.COM PAGE 4
In the first two months, under the leadership of the Central Committee of the Communist Party of China with Comrade Xi Jinping as the core, all regions and departments took Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era as the guideline, implemented the spirit of the 19th National Congress of the Communist Party of China (CPC) and the Central Economic Work Conference, adhered to the general working guideline of making progress while maintaining stability, stuck to the new development philosophy, focused on the supply-side structural reform and strongly promoted high-quality development, therefore the overall economy maintained steady performance and good growth momentum, getting off to a good start with new growth drivers thrived, economic structure optimized and quality and efficiency improved. All the data in this section refers to the first two months of 2018. Industrial production rose 7.2% year-over-year. State owned companies led the growth with 9% increase while mining increased only 1.6%. High technology companies had an 11% increase versus the same period last year. Investment in fixed assets was 4.4 trillion yuan which is a 7.9% increase over last year. The subsector of private investment grew by 8.1%. Consumer retail sales increased by 9.7% yearover-year. Growth was significant in both urban and rural regions. Online sales grew by 37.3%. The chart below shows the consistent strength in China s economic growth. China announced it expects its economy to grow at 6.5% rate in 2018.The goal for 2017 was 6.9%. They indicated the rate is lower than the past years but reflects the country s objective of reining in financial risks. The government intends to reduce its budget deficit to 2.6% of GDP from 3%.Just so America understands who it is dealing with, China might restrict spending but expects to increase spending on military by 8.1%. HIGGINSINVESTMENT.COM PAGE 5
Reflection What changed? Sometimes the markets don t make sense and sometimes they do. One of the primary examples of sense or nonsense is electric cars. Tesla is in the news for a couple of reasons this past week. One, they are now letting Canadians configure their orders for the Model 3. Many of these orders were originally placed two years ago. The production rate for the Model 3 is way below target leading some to speculate the company is in financial stress. Over the past year many auto manufacturers indicated they were making a push to develop electric cars. Volvo announced that all their cars will be electric or hybrid by 2019. This combined with the 500,000 back orders for the Tesla model 3 will lead to increased demand for car batteries and their key components such as Lithium. The chart below shows that the time to invest in lithium may have come and gone. Lithium prices are almost back to where they were last summer. As time passes it gets closer and closer to the time when manufacturers need lithium for their new models. It seemed like and easy way to make money. It is possible that the price had already risen to reflect the future demand and any delay in production would be a disappointment. While Lithium prices were rising the price of a company that runs convenience stores at gas stations also soared. If electric cars are gaining market share, fewer cars will be stopping at gas stations and going to the attached convenience stores. There are two Canadian companies that have consolidated gas stations and convenience stores. One of the companies is not cheap and trades at more than 3 times book value. If you buy into the macro trend that electric cars will take over this would be a stock to avoid. Over the past two years you would have lost money betting against the success of this company. You might be right in your macro theme but it might take years for you to be proven right. HIGGINSINVESTMENT.COM PAGE 6
Then there is Tesla itself. Some have indicated it could go bankrupt based on the losses related to their Model 3. On April 1 st, yes April fool s day, Elon Musk posted a picture indicating Tesla was bankrupt, funny ha ha. The company is losing literally a billion dollars per quarter. They are producing a fraction of cars they previously promised. At the end of Q3 last year Tesla indicated they would produce 2,500 Model 3s per week by the end of the first quarter of 2018. The ended the quarter at 2,000 in the final week but it was far from a gradual ramp as a few weeks earlier they were producing 750 cars per week. The stock has been extremely volatile as the bulls and the bears wrestle with each company news release. This is a case of a macro theme that definitely has two sides to the story. There are other macro themes such as dividends from pipeline related stocks. Two of the companies have reiterated their commitment to increase their dividends by 10% for the next few years. Some bearish investors state the game is over and these stocks should be avoided. One article I read had a negative case if they grow and if they don t. If they get approval for their major expansion they will need to raise equity to fund the growth. If they do not get approval for the projects rate of revenue growth will be less than expected and they will not be able to grow their earnings. It is interesting that growth can be a negative and a positive in the same article. I like the fact the companies have a solid base of earnings and have reiterated their dividend expectations. The stocks have been underperformers year to date in 2018. I believe the dividend will permit you to earn while you wait for the future expansion. Near term they have been losers but there is an argument to see pipelines approved rather than shipping oil by rail. In each of the cases above I assumed there was some logic to the arguments however. A reversal and moderate expansion of a line from Quebec to Sarnia was rejected as it would deliver dirty oil sands oil through Quebec. The increased ship traffic would be a risk to whales in the St. Lawrence. It is interesting the ships currently bring oil to Quebec via the St. Lawrence do not seem to have the same risk of hitting a whale as a ship loaded for export. The negative argument won and the oil was not shipped from Western Canada to Quebec but Quebec still receives oil from mid-eastern countries with lax environmental laws and limited freedom for their people. C est la vie. Asset Mix: We expect the equity markets to be volatile but provide positive returns over the coming year. Summary An asset is worth what someone is willing to pay for it; and the value of an asset is the cash it will generate over its life. John Kay In the reflection section we discussed some macro trends on which investors have been focused. The interesting part of the analysis is the I told you so s may be wrong. For instance, I hear electric cars are going to dominate so I should purchase their inputs. So far this year the price of lithium, a key ingredient in car batteries has done nothing but decline. It may be the price of lithium already reflected the coming demand. The other side of the argument relates to companies that have grown by expanding through purchases of gas stations. I am not sure if the gas stations will prosper if the electric car macro trend is correct. HIGGINSINVESTMENT.COM PAGE 7
It may seem a bit trite to say the market will fluctuate but it definitely has each month this year. You might get the macro trend correct but get the timing wrong or you might get hit by an unexpected trade war between the US and China. As the trade rhetoric increased so has the Canadian dollar. Not what you would expect, but some argue Trump will settle NAFTA if he wants to go after China. It is hard to make long-term investments when new threats are created each month. However, if you buy quality companies you may incur short-term negative performance but be positioned for long-term success and income from dividend paying stocks. Disclaimer: This material is for information purposes only and is not an offer to sell or the solicitation of an offer to buy any security. The opinions reflect those of the author and are not to be relied on for investment decisions. The comments are provided to give the reader something to think about and are not investment advice. HIGGINSINVESTMENT.COM PAGE 8