Mackenzie All Cap Value Team
- The final quarter of the year was coloured by the outcome of the U.S. elections as campaign promises made by President Elect Trump filtered into equity markets. Global equities performed well during the quarter, led by the Japanese Nikkei Index which climbed 16.4% (in local currency). Canadian equities, as measured by the S&P/TSX Composite Index, and U.S. equities, as measured by the S&P 500 Index (USD) were up 4.5% and 3.8%, respectively, performing in-line with other developed world, market indices. The Hang Seng was the only major market to register a decline.
- Value style investing performed well across all market capitalizations in Canada during the quarter. Canadian large- and mid-cap value stocks outperformed smaller cap stocks, a reflection of the exposure to gold in the small cap segment. In the U.S., value companies also performed well across all market cap segments, with small caps leading the way. U.S. small caps tend to exhibit a strong correlation to the domestic market and stand to benefit from the implementation of proposed deregulation and pro-growth policies of the incoming administration.
- As expected the U.S. Federal Reserve (the Fed) increased the overnight lending rate by 25 basis points in December, and signaled the start of a march to higher interest rate levels. This helped lift prices higher in the Financials sector as investor expectations for a widening of net interest rate margins (the spread between a bank’s borrowing rate and lending rate) were raised. The surprise election of Donald Trump bolstered Financials further as investors considered how potentially inflationary policies could impact the timing of further rate hikes by the Fed. As a result, Regions Financial and Wells Fargo, two banks held in our funds with U.S. exposure contributed to performance over the quarter. Canadian banks, led by the Bank of Montreal (BMO), a core holding across most of our funds, also responded favourably and delivered strong returns. BMO has developed a large footprint in the U.S., a strategy that should continue to serve it well in a rising rate environment south of the border.
- The interest rate increase was a negative for Utilities and REITs, sectors that are often viewed as bond proxies and become less desirable when the yield on risk-free assets (U.S. treasuries) climb. Gold prices were also down, falling 12% to US$1,150 in the final quarter of the year on the prospects for higher real interest rates and a stronger U.S. dollar. Renewed optimism and an increased appetite for risk also lured investors out of gold, which is traditionally viewed as a store of value. We remain underweight gold across all funds in the Mackenzie All Cap Value suite.
- In November, OPEC committed to making production cuts of roughly 1.2 million barrels per day, causing oil prices to climb roughly US$10, to finish the year at US$54. Unsurprisingly, energy stocks, a material portion of the Canadian market performed well and contributed meaningfully to Canadian equity gains.
- The Mackenzie All Cap Value suite of funds outperformed their respective benchmarks over the quarter, as our investors should expect when Value style investing is in a period of strong performance.
Outlook & Strategy
- Like a rising ocean tide filling in the gaps of a rocky shoreline, fourth quarter market appreciation pushed already elevated equity valuations higher, further reducing the number of inexpensively valued areas of the market.
- There is a significant amount of optimism priced into the market at these levels. Many of President Elect Trump’s pro-growth policies would be positive for the equity market, however it remains to be seen how many of these campaign promises will be enacted, and if they are, when the effects of such policies would be fully realized in the economy. There is some risk the market will back peddle, conceding some portion of recent gains if earnings growth does not rise to meet healthy expectations.
- Despite a run up in housing prices, we do not believe an increase in interest rates will significantly impact affordability in Canada. The Canadian economy remains stable, albeit lackluster compared to expected growth in the U.S., and Canadian household debt servicing levels are also stable.
- We expect the price of oil will trend higher as demand/supply fundamentals move toward balance. The funds are currently underweight exploration and production and overweight midstream businesses and are therefore less levered to the oil price. We will evaluate this tilt as we proceed into 2017, and should fundamentals change we will follow our strict value discipline to allocate capital where we see the best opportunities.
- Despite elevated prices in equity markets, we have found value in the Health Care sector and took the opportunity during the fourth quarter to add AmGen Inc., a leading U.S. biotechnology company. Shares are trading at 5-year low valuations and offered an approximate 3% dividend yield at the time of purchase. The company generates over 7% free cash yield while maintaining a robust R&D spending program. Legacy drugs account for over 70% of current revenues and also represent the largest risk as competition threatens to erode these revenues. New drugs in the pipeline have the potential to offset some of this pressure but ultimately the company will need to acquire other drugs with its fairly hefty cash hoard. If the U.S. government decides to allow cash repatriation back to the U.S. at a low tax rate, Amgen stands to benefit significantly as most of its cash is held overseas (domestic cash has been used to pay dividends) and the acquisition target pool is much deeper in the U.S. than it is externally.
- We maintain our view that North America has entered the later stages of a bull market and, as a result, will continue to hold small- and mid-cap exposure at the lower end of our historical range. We believe our disciplined, bottom-up value investment style and balanced approach to portfolio construction will serve unitholders well both in the current value-friendly environment, and over a full business cycle.