Tag Archives: georgia

Loans, Write-Downs And Shares…Oh My!

My family and I recently went to see the musical Wicked . Having already been with my wife when it first opened in 2003, I was thrilled to relive the awesome and spine-tingling performance with my kids. The creative genius of Wicked is its backstory – the plot that no one hears throughout the Wonderful Wizard of Oz . Turns out, the wizard isn’t really all that wonderful, and the witch isn’t so wicked after all. This got me thinking about parallels to the world of finance and how things aren’t always as they seem. We all know that the S&P/TSX Composite Index is heavily skewed toward the financials (37%), energy (20%) and materials (12%) sectors, but attitudes towards these industries have become rather split lately. In the past few years, financials have been all aglow thanks to consistently improving quarterly results, whereas the resource sectors have been a source of pain amid lower earnings, dividend cuts and write-downs. While faith in the financial sector may be justified, investors might not realize just how dependent the Canadian stock market has become on its earnings and dividends. According to data compiled by Bloomberg, while financials make up more than a third of the market cap, the sector accounts for more than 50% of the earnings and slightly less than half of the dividends paid on the S&P/TSX Composite Index. Click to enlarge Something wicked this way comes? Outsized dependencies are rarely a good thing in investment portfolios. For example, in the late 1990’s investors became overly dependent on technology companies trading at ever higher multiples, and then found themselves in a post-financial-crisis love affair with emerging markets. In both of these cases, investors paid too little attention to the backstory: technology had become more than a third of the S&P 500 and paid no earnings, and emerging markets had become reliant on leverage and an ever-expanding China. Investors also became overly dependent on U.S. financials a decade ago when the sector contributed more than 50% of the S&P 500’s earnings and dividends in 2006 only to fall off a cliff when the financial crisis hit two years later. The financial sector also grew to almost a quarter of the listed market in 2006, well above today’s level of 17% (still high but just not as high). Does this mean Canadian financials are due for some sort of rude awakening? Not necessarily. It depends on whether Canadian banks will report more bad loans and will have to incur larger write-downs than are currently reflected in loan loss provisioning or the share price. Intuitively, the nearly 70% decline in oil prices over the past two years and the broadening difficulties in the Canadian energy patch would imply a greater risk of loan defaults. Moreover, banks could see declining revenue growth and weaker revenues as the indirect consequences of low oil prices work through the extensive supply chain. But for now, these worries are the backstory. Canadian share prices are following the lead story: The banks’ exposures are manageable, the banks are prepared, and they continue to stress-test their loan book. Importantly, investors should know what their exposures are. Right now, investors in Canadian stocks are highly dependent on earnings and dividends from the big banks. If Canadian financials were to dip, investors could be in for a rude awakening. With any luck, the energy and materials stocks won’t seem as wicked if the rise in commodity prices in recent weeks supports upward earnings revisions in the next few quarters. The best outcome for reducing dependency on the financials is growing earnings from other sectors, not falling earnings from the banks. What can Canadian investors do to help reduce dependencies and limit outsized domestic exposures to the financial, energy and materials sectors? I would recommend considering allocations to two sectors that are underrepresented in the Canadian equity markets, such as global healthcare and technology, where there has been better dividend growth and stronger secular growth trends. Source: Bloomberg. This post originally appeared on the BlackRock Blog

Loans And Write-Downs And Shares… Oh My!

My family and I recently went to see the musical Wicked . Having already been with my wife when it first opened in 2003, I was thrilled to relive the awesome and spine-tingling performance with my kids. The creative genius of Wicked is its backstory – the plot that no one hears throughout the Wonderful Wizard of Oz . Turns out, the wizard isn’t really all that wonderful, and the witch isn’t so wicked after all. This got me thinking about parallels to the world of finance and how things aren’t always as they seem. We all know that the S&P/TSX Composite Index is heavily skewed toward the financials (37%), energy (20%) and materials (12%) sectors, but attitudes towards these industries have become rather split lately. In the past few years, financials have been all aglow thanks to consistently improving quarterly results, whereas the resource sectors have been a source of pain amid lower earnings, dividend cuts and write-downs. While faith in the financial sector may be justified, investors might not realize just how dependent the Canadian stock market has become on its earnings and dividends. According to data compiled by Bloomberg, while financials make up more than a third of the market cap, the sector accounts for more than 50% of the earnings and slightly less than half of the dividends paid on the S&P/TSX Composite Index. Click to enlarge Something wicked this way comes? Outsized dependencies are rarely a good thing in investment portfolios. For example, in the late 1990’s investors became overly dependent on technology companies trading at ever higher multiples, and then found themselves in a post-financial-crisis love affair with emerging markets. In both of these cases, investors paid too little attention to the backstory: technology had become more than a third of the S&P 500 and paid no earnings, and emerging markets had become reliant on leverage and an ever-expanding China. Investors also became overly dependent on U.S. financials a decade ago when the sector contributed more than 50% of the S&P 500’s earnings and dividends in 2006 only to fall off a cliff when the financial crisis hit two years later. The financial sector also grew to almost a quarter of the listed market in 2006, well above today’s level of 17% (still high but just not as high). Does this mean Canadian financials are due for some sort of rude awakening? Not necessarily. It depends on whether Canadian banks will report more bad loans and will have to incur larger write-downs than are currently reflected in loan loss provisioning or the share price. Intuitively, the nearly 70% decline in oil prices over the past two years and the broadening difficulties in the Canadian energy patch would imply a greater risk of loan defaults. Moreover, banks could see declining revenue growth and weaker revenues as the indirect consequences of low oil prices work through the extensive supply chain. But for now, these worries are the backstory. Canadian share prices are following the lead story: The banks’ exposures are manageable, the banks are prepared, and they continue to stress-test their loan book. Importantly, investors should know what their exposures are. Right now, investors in Canadian stocks are highly dependent on earnings and dividends from the big banks. If Canadian financials were to dip, investors could be in for a rude awakening. With any luck, the energy and materials stocks won’t seem as wicked if the rise in commodity prices in recent weeks supports upward earnings revisions in the next few quarters. The best outcome for reducing dependency on the financials is growing earnings from other sectors, not falling earnings from the banks. What can Canadian investors do to help reduce dependencies and limit outsized domestic exposures to the financial, energy and materials sectors? I would recommend considering allocations to two sectors that are underrepresented in the Canadian equity markets, such as global healthcare and technology, where there has been better dividend growth and stronger secular growth trends. Source: Bloomberg. This post originally appeared on the BlackRock Blog

One Investment… Three Ways To Profit

$150 billion is a lot of money. And due to some planned changes the makers of S&P and MSCI indexes are making, that’s the amount of money that is likely to flow into shares of real estate investment trusts (REITs) over the next few months. You see, up until now, REITs have been considered “financials” for the purposes of sector weighting. Well, that’s just crazy. A landlord that owns a portfolio of rental properties really has little in common with a bank or an insurance company. Yet, that’s where REITs have historically been lumped. But now that the index creators are fixing their mistake, there are going to be a lot of mutual fund managers and other institutional investors who will be pretty dramatically out of balance. According to recent research by Jefferies, that $150 billion is how much would need to be reallocated to REITs so that mutual fund managers can meet their benchmark weightings. I expect that the real number will be a decent bit lower than that. A lot of managers will be content to be underweight REITs relative to their benchmark. But even if it ends up being half that amount, that’s a big enough inflow to seriously buoy REIT prices. The entire sector is only worth about $800 billion. I’m telling you this now because we’ve been mentioning REITs in Boom & Bust of late, and so far, the results have been solid. But what I want to mention today is potentially even better. If you believe in the REIT story and expect REIT prices to go higher, and someone told you that you could buy a portfolio of REITs for 90 cents on the dollar, wouldn’t you jump at the opportunity? Well, that’s exactly the situation today in the world of closed-end funds. And in Peak Income , the new newsletter I write with Rodney Johnson, I recently recommended a closed-end REIT fund trading for about 90% of net asset value. Out of fairness to the readers who pay for that information, I can’t share the specific stock with you. But I can definitely tell you how I chose this fund and what you should look for when evaluating closed-end funds on your own. With most mutual funds, you can really only make money one way: the stocks in the portfolio must rise in value. Sure, dividends might chip in a couple extra percent. But for the most part, you only make money if the stocks the manager buys go up. That’s not the case with closed-end funds. In fact, you can make good money in three ways with this particular investment vehicle: #1 – Current dividend is generally a large component of returns. Unlike traditional mutual funds, closed-end funds are specifically designed with an income focus in mind, so they tend to have some of the highest current yields of anything traded on the stock market. This is partially due to leverage. Closed-end funds are able to borrow cheaply and use the proceeds to buy higher-yielding investments. This has the effect of juicing yields for you. #2 – Returns delivered via portfolio appreciation. Just as with any mutual fund, you make money when the stocks your fund owns rise in value. #3 – You have the potential for shrinkage of the discount or an increase in the premium to net asset value. That sounds complicated, so I’ll explain. Because closed-end bond funds have a fixed number of shares that trade on the stock market like a stock, the share price can deviate from its fundamentals just like any stock can. Sometimes, you can effectively buy a good portfolio of stocks, bonds or other assets for 80 or 90 cents on the dollar … or even less from time to time. But often, that same dollar’s worth of portfolio assets might be trading for $1.10 or higher on the market. Well, I’m not a big fan of paying a dollar and 10 cents for just a dollar’s worth of assets… no matter how much I might like those assets. But I do rather like getting that same dollar’s worth at a temporary discount. And when that discount closes, your returns outpace those of the underlying portfolio. The ideal closed-end fund investment should have solid potential from all three factors. It will pay a high current dividend, will have a portfolio poised to rise in value, and will be trading at a deep discount to net asset value. Be sure to look for those three things when you research closed-end funds. This article first appeared on Sizemore Insights as One Investment… Three Ways to Profit . Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results. Original Post