Mackenzie All Cap Value Team
- Global equities moved higher in the third quarter although results varied by geography. Emerging markets as a group led performance, followed by European and Japanese equities. Canadian stocks were in the middle of the group while U.S. equities lagged. The S&P/TSX Composite Index (SPTSX) gained 5.5% on a total return basis in the third quarter.
- The key differentiator of performance for Canadian stocks related to Gold. Gold prices were flat this quarter, a marked change from the first half of the year when the metal gained roughly 25%. Gold stocks represent just under 8% of the S&P/TSX Composite Index and combined with an average price decline of 9% for stocks in the group, the sector represented a meaningful drag on Canadian equity performance. We believe much of the gold weakness is associated with the strengthening U.S. dollar late in the quarter as a result of a near 80% consensus expectation of a rate hike by the U.S. Federal Reserve before year end.
- Similarly, interest rate sensitivity could be seen in other areas of the market as well. Insurance stocks, led by Manulife Corporation performed well, consistent with the expectation of a move higher in rates. Conversely, stocks that tend to underperform when rates are expected to rise such as REITS, Utilities and Telecom stocks lagged this quarter.
- Finally energy stocks, which were not particularly strong over the entire quarter, surged sharply in the last few days of Q3 and into the fourth quarter. This was because OPEC announced it would cut crude oil output, for the first time in 8 years, by 750,000 barrels per day. Oil prices moved back above $50US, the highs of the last year, and carried energy producers with them.
- Broadly speaking, growth stocks across the market capitalization spectrum outperformed value stocks this quarter. This was a headwind to the All Cap Value investment style but stock selection in a few funds allowed for outperformance while longer-term outperformance was maintained across the board with good absolute third quarter contributions.
Outlook & Strategy
- Consistent with our views last quarter and in conjunction with continued equity price escalations amidst tepid earnings growth, overall valuations in Canadian and U.S. equities remain elevated. Currently the consensus P/E multiple on forward earnings per share is 16.8x for the SPTSX compared to the historical average of 15.2x. The S&P 500 Index sits at 16.7x P/E compared to 15.5x on average historically.
- We believe we are well into the bull market phase of this market cycle. Typically at this point in the cycle, unitholders should expect that our exposure to smaller capitalization stocks would be closer to the lower end of the historical range. Smaller cap stocks tend to perform well coming out of a correction, when valuations are broadly depressed and discounts to fair market value are large. These are periods when our conviction and our desire to take risk is at its greatest and is reflected in a higher exposure to small and mid-cap stocks. We do not believe the current environment warrants such risk taking and as a result we maintain an exposure to small and mid-capitalization stocks that is below 30%.
- We remain focused on finding and investing in attractively valued stocks nonetheless, but given broadly elevated valuations, we believe the opportunity set of investable stocks is narrower today. We have found opportunities in financial stocks, and in particular U.S. banks. Our net exposure to bank stocks has remained stable but we have a greater concentration in U.S. exposure. This is evident in our U.S. bank holdings directly combined with an increased exposure to U.S.-biased Canadian banks. For example, we have increased our exposure to TD Bank while eliminating our holding in CIBC in Mackenzie Canadian All Cap Dividend Fund, which has the largest domestic exposure of the big 5 banks.
- Most of the activity in the funds in recent months have come from pricing dislocations with specific stocks and not from a concentration of opportunities within a specific sector. For example, in energy we have increased our exposure to Crescent Point Energy, where shares have substantially underperformed peers due to a dilutive equity issuance which disappointed investors. We believe Crescent Point has one of the most inexpensive valuations in the group. The company generates among the highest levels of profitability on a barrel of oil amongst its peers. It now has a stronger balance sheet with the flexibility to accelerate spending on its large reserve base while overall decline rates in production continue to ease. We believe a normalization in valuations back to fair value levels combined with a sustainable 2% dividend yield positions Crescent Point well within the portfolio. Importantly the increased weighting in Crescent Point was funded by sales of other energy producers where valuations were not as compelling. Our overall exposure to energy producers did not change.
- In addition, risk mitigation plays a more significant role in our investment decisions in the current environment. We have reduced our exposure to the volatile gold sector while increasing our exposure to economically-insensitive healthcare stocks. Food price deflation in the U.S. has depressed grocery stocks so we recently added shares of Kroger to the Mackenzie Canadian All Cap Dividend Fund. Staples stocks generally provide defensive characteristics to the portfolio and we believe Kroger offers an attractive valuation at the same time.
- 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 focused on risk mitigation through exposure dampening and good diversification.