Hello everyone and welcome to today’s live chat at Inside the Market. Your own questions are welcome at any time. We’ll be getting underway shortly.
Thanks for joining us Chris, we're ready to roll.
Chris, the last couple of weeks have seen a bit of a shift in market thinking, with more observers thinking that the Fed will start hiking rates sooner than earlier expected – perhaps even in the first quarter of next year. Small caps and techs, as we saw yesterday, are losing favour, as a risk-off mentality returns to markets. What’s your view on the state of markets right now?
We certainly live in interesting times. The liquidity that the market has experienced since the financial crisis has been unprecedented, so it's certainly natural to worry about dislocations as policy normalizes.
While the Fed is doing their best to ease the market into a period where they won't be pumping in liquidity, we've seen the Bank of Japan and now the ECB take the baton so to speak and embark on their own program.
We think that the Fed will remain low, and that any moves will be very measured, given the size of their own balance sheet, they really can't afford to have rates get out of hand
Periodically you will have scares as people contemplate whether or not the economy can handle higher rates, we've just had a mini one the last few days, and just before the chat started we had Hilsenrath say that he expects language to remain accomodative
I think it's fair to say stick with lower for longer until proven otherwise
That probably means the path of least resistance for equity markets is higher as well
For those who may not know, Jon Eric Hilsenrath is the chief economics correspondent for The Wall Street Journal, who is known to be extremely well tapped in on Fed matters.
We're nervous about other things, the independence vote in Scotland has the potential to disrupt the markets, but generally we are positive.
We try to cover these issues in our blog and our weekly newsletter. For anyone interested, you can sign up on our website, www.otterwoodcapital.com
Yields, at least judging by the 10 year treasury, have gone up quite a bit this month. Do you see that trend continuing or have they likely peaked for now?
We see yields as rangebound, earlier this year it was absolute consensus that rates were going up, based on improving fundamentals in the US economy. Of course the exact opposite happened, and there's a variety of reasons for that
Positioning was one, the trade in rates was so one sided that when US GDP dissapointed there was a massive rush to cover any short bond positions
With Europe moving towards quantitative easing, all things equal that should help to keep a lid on European sovereign yields, so as an international investor you have a choice, should you buy the Spanish 10 year at 2.35 or the US 10 year at nearly 2.60
When you factor in the outlook is bullish for the US dollar and terrible for the Euro, and you get extra yield from a stronger economy, we think the answer is pretty simple
Christine Hughes our CIO covered this issue extensively in a video which is available on our website, for anyone who's interested.
Can you tell us a bit about the strategy of your funds?
Certainly, we're a bit different in that we start by looking at the macro environment, most notably the bond market, which we find tends to lead equity markets, and we use that top down approach to decide where and what to invest in
In equities, we try and identify where we are in the economic cycle, based on rates, and identify any other themes that are "big picture", and invest accordingly
Preservation of capital is of the utmost importance to us
Let's go to our audience for the next question. Not sure though this is his real name!
We're quite positive on Canadian energy in general
Last year you had a bit of a perfect storm hit our energy producers given the US shale revolution and the infrastructure constraints that have plagued Canadian oil
This year has been the exact opposite. Rail stepped up to fill the gap left by delays in Keystone XL, the economy remained strong keeping demand robust and as an extra benefit, the weaker CAD is helping Canadian producers to realize 10% better prices
Much has been made of US energy independence, but if you look at the statistics, the US has increased their imports of Canadian oil, its been overseas crudes that have been displaced
We think this continues, US refiners are set up to accept Canadian heavy and are making excellent margins, rail is getting crude to the Gulf, and the stocks are attractively priced
Crude prices have had a lousy week though. Do you see that trend continuing?
To put it simply, no, we don't
I think the factor that has changed recently is the movement on the part of Saudi Arabia to curtail their production
The market has a lot of optimism on Libya restarting, and further exports from Iran and Iraq. We're skeptical that these countries have sounded the "all clear", just this morning we had some negative headlines out of Libya, so you will get periods of volatility in their supply
But even more importantly, Saudi Arabia is still the swing producer. Even with their recent downshift, they're supplying the market with around 9.5mm barrels a day. We think they would be more comfortable at 8mm, those 1.5mm barrels are being pumped to make up for the outages in the countries I previously mentioned.
As long as Saudi Arabia shows willingness to police the market, as they have consistently done when Brent oil has traded under $100 a barrel, we feel the downside is limited.
Sticking with the topic of energy, here's our next question from Mike
CNQ = Canadian Natural Resources
We really like CNQ. They benefit from the Canadian heavy oil thesis I outlined below, but on top of that, they're also Canada's second largest gas producer, and we're bullish natural gas as well.
The valuation is extremely reasonable at approximately 6x cash flow for a company of this size and quality, and over the past few years theyve stepped up their buyback and dividend to get more cash back to the shareholder
There's also a good chance they follow in the footsteps of EnCana and look to monetize their royalty portfolio, something we think could bring in north of $2 billion in proceeds. Given their financial flexilibity is already top notch, we think there's a good chance that cash makes its way back to shareholders as well
As far as target price, I could easily envision the stock trading well north of $50 in that scenario