Love Letter – February 2018

February 12, 2018

Interest rates may be rising but runway for global growth still long

2017 was a strong year for global markets as virtually every equity index finished well into positive territory. The reason for this is straightforward: co-ordinated global economic growth is occurring for the first time in many years, lifting business, consumer, and investor confidence to multi-year highs. It has taken much longer than expected, but the slashing of interest rates after the 2008-2009 financial crisis is only now having the intended widespread stimulative effect. Indeed, initial estimates indicate that 2017 global GDP expanded at the fastest pace in six years and expectations are for further acceleration in 2018.

With global economies having been rescued by prolonged ultra-low interest rate policy, central banks have now understandably turned their attention to removing this unprecedented level of stimulus. Some central banks such as the U.S. Federal Reserve, Bank of Canada, and Bank of England have already started to gradually raise rates. The European Central Bank, Bank of Japan, and Chinese central bank have yet to start. With short-term rates in Europe and Japan still sitting at -0.4% and -0.1%, respectively, pressure is building for these economies to begin removing emergency-era stimulus (exhibit 1). We would interpret a decision to raise rates in these latter regions as a vote of confidence by central bankers. Read More…

The Love Letter – December 2017

December 18, 2017

Hockey and donuts define us, but we’ll pass on the banks (for now)

It’s been a year of celebration as we’ve observed Canada’s 150th birthday. It’s also been a time of introspection as we ask ourselves what defines Canada and Canadians. Our unscientific list includes:  hockey, Tim Horton’s, maple syrup, national parks, the loonie, multiculturalism, universal healthcare, the maple leaf, Terry Fox and natural resources. If this was an exhaustive list it very well could include the pervasive ownership of Canadian banks within investment portfolios.

Canadian banks have earned a global reputation for being well capitalized and managed. These banks are ubiquitous in domestic investment portfolios partly because they collectively represent almost 25% of the Canadian equity market and have a solid track record of profitability, dividend growth and share price appreciation. Given all this, why are there little to no Canadian banks in the discretionary portfolios that we manage for our clients?

Portfolio management is about allocation of assets to maximize risk-adjusted returns. Asset allocation inherently means making choices among a vast universe of investments. With this in mind, we made a strategic decision to invest in U.S. banks instead of Canadian ones after the 2016 U.S. election because we expected the former to benefit from tax cuts, deregulation, and more favourable economic conditions. This was the right decision (see Exhibit 1), and based on our current outlook we continue to favour this positioning.

Many elements of our U.S. bank thesis are coming to fruition. Tax reform legislation has gained congressional approval and is undergoing last-minute tweaks before being sent to the White House for sign-off. If passed into law, corporate tax cuts could become effective in early 2018, driving future earnings estimates higher. Proposed and enacted deregulation of the U.S. financial system, including changes to capital requirements and compliance, is expected to improve profitability further. With U.S. interest rates rising at a faster clip than other developed markets, net interest margin (generally the largest contributor to bank profits) has been expanding at an above average rate. Finally, a combination of low unemployment, healthy consumer balance sheets, and reasonable housing affordability suggest that loan growth for U.S. banks should remain strong.

Conversely, our 2018 thesis for the Canadian economy calls for subdued growth brought on by trade uncertainties, record levels of consumer debt, cooling housing market (see below), sluggish oil/natural gas prices, and left leaning fiscal policy that may discourage investment. Amid this backdrop, we expect global investor sentiment on the Canadian economy, Canadian dollar, and Canadian equity market (including Canadian banks) to remain cautious as we head into 2018. Unless this outlook improves or valuation becomes more attractive, we expect to remain on the sidelines when it comes to Canadian banks.

New mortgage rules could result in further home price weakness in 2018

New stress tests introduced by the Office of the Superintendent of Financial Institutions (effective January 1, 2018) will require new conventional mortgage borrowers to qualify using the Bank of Canada’s 5-year posted interest rate (currently 4.99%) rather than much lower negotiated rates available at most banks. Using predefined debt service ratios, the new rules will reduce the amount prospective buyers will be able to borrow, ultimately reducing home price affordability by 17%-20% (see exhibit 2).


From all of us at The Rosedale Group, please accept our best wishes to you and your families for a wonderful holiday season and healthy, happy, and prosperous 2018!

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The Love Letter – November 2017

November 29, 2017

Some big questions as we approach 2018

As we approach the end of 2017 and start to set expectations for 2018, one of the biggest questions we’re facing is: will the Toronto Maple Leafs end a 50+ year drought by winning the Stanley Cup! At the time of writing, the Maple Leafs were ranked second most likely to win this season’s Cup by Vegas bookies. From an investor’s perspective, the number one question as we look into next year is: how long will the current economic cycle and equity market uptrend continue? Read More…