Mackenzie All Cap Value Team
In the second quarter Canadian equities continued to outperform most global equity markets and developed market equities in particular, an extension of the trend witnessed since the early part of the year. Resources, which make up approximately 31% of the S&P/TSX Composite Index (SPTSX) were the key driver of this outperformance. Gold and crude oil were up 7% and 26%, respectively. We believe much of the strength in these commodities, is being driven by mounting supply pressures while demand remains firm. Oddly, this commodity strength occurred with only a 0.7% weakening of the US dollar against the Canadian dollar, a modest change compared to the strong moves we have seen in the exchange rate in the last few years for a commensurate move in commodity prices. Higher dividend yielding sectors also contributed to the gains in Canadian equities, though the impact was more meaningful in the S&P/TSX Dividend Index (TXDC). Utilities, Telcos and REITS moved higher as weaker US employment data and the Brexit vote made the likelihood of interest rate increases an unlikely event any time soon. Consumer Staples, Consumer Discretionary and Information Technology, declined in the quarter, offsetting some of the gains in the Canadian indices.
The All Cap Value team performed strongly in the quarter across our offering of funds. As is typical, stock selection provided the greatest source of outperformance for our funds this quarter. This was most notable in our ownership of Oil & Gas Exploration and Production stocks. We have had a skewed exposure towards producers with high operating leverage to rising crude oil prices, the area where we have found the best relative value in the sector. Surging oil prices in the quarter propelled holdings such as Encana Corp. and Arc Resources Ltd higher, while large integrated producers like Suncor Energy, where we were underexposed, were flat on the quarter. Similarly, in the Gold sector, we had a concentration in a few key holdings within the group. The best of those this quarter was Barrick Gold, which climbed over 56%. Barrick has benefitted from a declining cost structure and an improving balance sheet, but the key driver was the near US$100 rise in the gold price this past quarter. Stock specific detractors included GNC Holdings Inc., which fell on weaker second quarter earnings as they execute a restructuring of the store base, as well as Linamar Corp., which declined on weakening sentiment towards auto sales.
Outlook & Strategy
Equity markets have been turbulent in recent years both in Canada and abroad, but despite this volatility, the trajectory of stock prices has been higher. In fact, from a long term perspective the S&P/TSX Composite Index (SPTSX) is near historical highs while the S&P 500 (SPX) closed the quarter at an all time high. This has occurred while economic growth, and by extension corporate profitability, has grown at a more modest pace than prior to the financial crisis. As such, overall equity valuations have expanded to levels that are modestly above fair value and this is based on our expectation of a continued low interest rate environment. As an indication, the consensus forward P/E multiple of the SPTSX and SPX is at 17.2x and 16.5x, respectively, both above their long term averages.
In the midst of this environment of low profit growth and extended valuations the All Cap Value team maintains a bias towards dividend paying stocks. All of our funds have a higher average dividend yield than that of their respective benchmarks. At the same time we continue to seek out attractively valued opportunities which offer a good risk/reward profile. For the most part, highly attractive valuations have been limited. Instead, more of investments have been focussed on good relative value, with greater risk mitigating characteristics. For example, in the Mackenzie Canadian All Cap Dividend Fund we added the shares of Intact Financial, Canada’s largest property and casualty insurer, after the share price declined due to the pending liability associated with the Alberta wildfires. Intact consistently generates a combined ratio below 100% while maintaining substantially higher profitability levels than their smaller competitors. Valuation levels were reasonable but not extraordinary and the investment offered a 2.7% dividend yield. Equally as important however was that the purchase was funded with proceeds from a reduction in our holding of Barrick Gold on the back of a sharp run up in share price as described above. Overall, we feel this transaction allowed us to reduce portfolio risk, while supplementing the dividend and stability of the fund.
Although few opportunities have existed to buy great values in the current environment, we will increase risk taking when these opportunities do arise. This quarter we raised our exposure in CP Rail materially in our Mackenzie Canadian All Cap Value Fund, to where it has become one of our larger exposures in the portfolio. In this case the share price decline of over 30% from a year ago created an opportunity to buy a much improved railroad trading at very attractive valuation levels. CP is the most inexpensive railroad stock in North America, operating in an oligopolistic industry. Shares also trade at the lowest absolute valuation levels in over 5 years, on earnings that are substantially more efficient and profitable than in the past.
We continue to expect broader trends described above to continue. Namely, slow growth and generally elevated valuations. In that context, dividends will continue to play an important role in our funds as we seek out attractively valued stocks. As these opportunities become more plentiful, investors can expect that our risk taking will increase. In the meantime, it is more likely that our investment actions will be more focussed on risk mitigation through exposure dampening and good diversification.