The outlook for Canadian equities? It’s good

June 14, 2013

Amidst the noise and turmoil of volatile day-to-day markets, it is beneficial to take a step back and ponder the age old question, “What is going on out there?”  When describing the angst in the market, two great quotes come to mind.

The first is from the great British economist John Maynard Keynes. According to Keynes: “Successful investing is anticipating the anticipations of others.”

At Leon Frazer, we are romantics. We truly believe the best way to create wealth is by owning well-managed, well-capitalized companies.

The second comes from Warren Buffett, one of the greatest investment minds of our times. “We believe that according the name ‘investors’ to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a ‘romantic,’” said Buffett.

Implicit in the Keynesian view is the idea of investing in a piece of paper called a stock, with the hopes of selling that stock for a higher price some time in the future. In its simplest terms, the Keynes camp treats markets as clearinghouses for paper transactions in securities. A good investment is one that is sold at a higher price, with the seller having properly anticipated the anticipation of others.

In contrast, the Buffet view of investing revolves around ownership. Investors own shares in a company, and participate in the rewards the company creates. Markets are viewed as allocators of capital. Rewards come in the form of dividends, as well as any appreciation in value of the ownership interest.

In the 1960s, Richard Nixon quoted Milton Friedman: “We are all Keynesians now.” Little did Nixon know how accurate he would be in describing our current investment environment.

In a world where short-term performance dominates attention, for many managers, trying to outguess the competition has become crucial to earning big bonuses or share option grants. With a financial press increasingly in need of content to cater to the fear and greed of investors, a short-term, trading-oriented investment style has flourished. The proliferation of hedge funds, algorithmic traders and activist investors over recent years is perfect evidence of Buffett’s non-romantic behaviour.

At Leon Frazer, we are romantics. We truly believe the best way to create wealth is via an ownership position in well-managed, well-capitalized companies. We recognize that well-managed companies tend to have a history of making sound business decisions, rewarding share owners, via increasing dividends, with the fruits of their decision-making. Well-capitalized companies not only weather economic storms, they also have the flexibility to take advantage of opportunities not available to companies which require continual financing.

For over seven decades, Leon Frazer has managed client portfolios with a singular focus on growing the income stream generated by the investments held. We look at the investing world today and see two historic anomalies. First, as we have discussed many times over the past few years, the dividend yield on stocks is now in excess of the yield on bonds. In our view, this has created a world that will continue to favour investments in equities, which offer owners not only high current income, but income that can grow. Second, we are now seeing traditional low- or no-yield cyclical resource and energy stocks with good balance sheets offering yields that are in many cases above the yield on the market in general. For the first time in decades, quality cyclical stocks are offering income opportunities on par with the more traditional dividend-growing consumer-oriented stocks.

In constructing portfolios that pass the test of time, assessing historical anomalies is more important than anticipating short-term economic events. As long as interest rates remain at historically low levels, dividend-paying equities, and especially dividend-growing equities, should continue to remain in the headlights of income-seeking investors rotating out of bonds.

Furthermore, with cyclical stocks now offering fundamental investment characteristics not seen in years, the outlook for Canadian equities is particularly good, especially as the Canadian market has been such a poor performer over the past year. George Frazer always said that “time in the market is more important than timing the market.” Amidst all the noise in markets today, that sage wisdom is well remembered.

Adapted from LFA Market Perspectives, May 2013