This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Find CIBC research on Bloomberg, Reuters, firstcall.com and ResearchCentral.cibcwm.com CIBC World Markets Inc., P.O. Box 500, 161 Bay Street, Brookfield Place, Toronto, Canada M5J 2S8 (416) 594-7000
Institutional Equity Research
Industry Update
June 16, 2010 Off The Press — Collective Research Series
CIBC's CIO Roundtable - Volatility And Slower Growth Sorting Through The Challenges
Funds have been shifting out of risky assets in recent weeks, reflecting concern about sovereign debt and global growth. Absent an outright sovereign default, we see those fears easing. The drag from fiscal tightening could keep risky assets to muted gains in choppy markets through 2010.
Longer-term fundamentals, however, remain favourable for Canada's risky assets. The country's resource endowments, resilient financial system and favourable demographics relative to other G-7 nations make it an economic contender looking out over a five-year horizon.
Another notable positive is in the healthier state of public and corporate sector balance sheets. These factors are no iron-clad recipe for national success in the near term, but do mean Canada is better-positioned than many of its competitors to deal with the challenges of the upcoming years.
Where economic growth goes, corporate earnings, dividends and other rewards for investors are likely to follow. Nimble asset allocation is likely to be rewarded by the current markets. We are recommending an overweight on equities, tempered by the European uncertainty.
CIBC World Markets does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
See "Important Disclosures" section at the end of this report for important required disclosures, including potential conflicts of interest. See "Price Target Calculation" and "Key Risks to Price Target" sections at the end of this report, or at the end of each section hereof, where applicable.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
3
CIBC’s CIO Roundtable Volatility with Slow Growth – The New Normal
Taking a Closer Look At The Future On June 17, we are pleased to present our inaugural roundtable of Chief Investment Officers engaging our analytical team (equity research and economics) on a variety of market-pressing subjects. From the issues surrounding the Euro zone to the implications of muted global growth, prospects for China and the demand on base metals, we expect to have a wide-ranging conversation. Is the U.S. recovery happening or could this just be a head fake, which will continue to have implications for the financial services sector on both sides of the border? With continued volatility and no distinct leadership in the market, the lustre of gold shines brightly, but will the spotlight last? Finally, while much has been made of Canada’s ability to skate through the global market challenges, are we immune from the sniffles, cold and fever that has beset much of the world? Will our consumer continue to look on the bright side and continue supporting Canadian retail stores and buying real estate?
In preparation for our discussion and to stimulate some of the conversation around the table, we have asked the analysts at CIBC to provide their perspective on many of the issues facing the markets over the next 12-18 months and tried to peer into the crystal ball for the 3-5 year outlook. We have tried to distill those views into this report. Avery Shenfeld, our Chief Economist, provides his sense on living in a world where growth is more lethargic and restructurings will continue. When it comes to equities, he has a mildly constructive view on their prospects. Peter Gibson, our Portfolio Strategist, has provided a somewhat complementary view to Avery’s perspective on growth, although they are not without their differences. While Peter believes the global economy is perilously close to a debt crisis, he thinks Canada’s equity market still has some legs – provided the U.S. economy skates through its challenges. Peter highlights his targets for a number of commodities, yields and valuations for the remainder of 2010. We have also provided our asset allocation recommendations, supplemented by a tactical view that is more trading-oriented. Finally, we have asked several of our fundamental analysts to outline their views on their verticals given the future that has been painted by Avery and Peter.
We are indebted to our clients for agreeing to lend their expertise/knowledge as key contributors to the CIBC roundtable. A special thanks to the following individuals:
Martin Hubbes, EVP & CIO, AGF Funds Inc.
Duncan Webster, CIO, CIBC Asset Management
John Wilson, CIO, Cumberland Private Wealth Management Inc.
David Rosenberg, Chief Economist & Strategist, Gluskin Sheff & Associates
Robert Spector, Chief Economist, McLean Budden Ltd.
Neil Matheson, SVP, Investment Strategy – Standard Life Investments Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
4
Economics Avery Shenfeld (416) 594-7356 Benjamin Tal (416) 956-3698 Peter Buchanan (416) 594-7354 Warren Lovely (416) 594-8041 Meny Grauman (416) 956-6527
From “V” to “U”: Living With Slower Growth The macro story matters. The business cycle, not stock picking, has ruled in the past two years as, moving in near unison, risky assets fell through March 2009, rebounded sharply thereafter, and then, more recently, gave up some ground. Given the tight correlations for risky assets, which link stocks, corporate bond spreads, and commodities into one risk-on, risk-off trade, performance in the CIO seat will critically depend on reading the cyclical and risk-appetite tea leaves correctly.
Implausible as it might have seemed at the trough of the Great Recession, the global economy has traced out the first stages of a classic, “V”-shaped rebound. In Canada, as sharply as it fell, real GDP has rebounded even more sharply, nearly returning to its pre-recession peak, although leaving the unemployment rate some 2%-points higher. South of the border, the US economy had a longer and steeper tumble, but it too has shown solid growth in output, if not employment. Long-suffering Japan has put together two solid quarters, and China’s GDP is up nearly 12% in the past year. All of which puts them in the V-for-victory camp as well.
Looking at the recent performance of risky assets, markets are sensing that today’s economic success story won’t last. In the near term, we share that sentiment. Economic growth looks set to decelerate notably in the second half of the year in most major economies (Exhibit 1), and global growth, due to top 4% this year, will be a half-point slower in 2011.
Exhibit 1. Global Economy To Slow In The Second Half
0
2
4
6
8
10
12
US Eurozone C hina
1H10F 2H10F
annualized q/q real GDP growth, %
Source: CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
5
Longer term, however, Canada enjoys a number of advantages in terms of its resource assets, demographics, and fiscal starting point. So while portfolios should now be adjusted to reflect the transition from V to U through 2011, next year could be the time to begin looking for opportunities to capitalize on a favourable medium-term picture for our economy.
Fiscal Policy: It’s A Drag Judging by trends in sovereign CDS markets and bond spreads, markets are still concerned about a near-term credit shock in the Euro zone, one that would begin with a sovereign default and spread to the banking system.
While that might still transpire, it seems less likely to happen in the next year. Europe’s recent collective borrowing proposal, with a potential IMF supplement, would be enough to refinance all of the weakest players’ maturities through 2011 (Exhibit 2). Austerity programs are likely to fall short of budget objectives, and will be difficult to sustain politically. Chances are, then, that Greece will face a debt restructuring a few years down the road, but fiscal belt tightening elsewhere could prevent that from being the first in a chain. In the interim, the lack of any additional evidence of a further move to the brink of default in the next few months should allow some of the recent flight to safety to be reversed. That would tend to shift assets away from safe-haven assets such as high-rated government bonds (Treasuries, Canadas), gold, and US dollars, and allow for a partial recovery in risky assets (corporate bonds, equities, and the Canadian dollar).
Exhibit 2. Stability Fund Covers Maturity
0
100
200
300
400
500
600
700
800
Debt refinancingJun10-Dec11
Stability Fund
€ billion
Spain
GreecePortugalIreland
IMF
EU
Source: CIBC World Markets Inc., Bloomberg
But equity markets may still be on to something. Rather than being hit by the one-time shock wave of sovereign debt defaults, investors could simply be disappointed by the pace of economic and earnings growth ahead. We’re less concerned than some about risks of a China-syndrome meltdown in East Asia. China’s monetary tightening will put a dent into housing prices in major cities and equities markets, but it’s only moving to fight bubbles in those asset markets because Beijing feels it can get more sustained growth in industrial development and exports. The recent retreat in the purchasing managers’ index still left it at a level consistent with 10% growth (Exhibit 3).
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
6
Exhibit 3. Chinese PMI Consistent With 10% GDP Pace
0
2
4
6
8
10
12
14
48 50 52 54 56 58
GDP y/y growth (%)
PMI
May 2010
0
2
4
6
8
10
12
14
48 50 52 54 56 58
GDP y/y growth (%)
PMI
May 2010
Source: CIBC World Markets Inc., Bloomberg
It’s the developed world where risks of a slowdown are more concerning. Europe stands alone in undertaking a major fiscal belt tightening this year. Its own growth trajectory will be helped by a weaker euro, offsetting most of the fiscal drag, just as Canada’s economy was sheltered in the 1990s deficit battle by a cheap exchange rate. But that’s a zero sum game for the global economy, and a stronger greenback will, in effect, transmit some of Europe’s fiscal drag to the US.
More troubling is that in the broader global economy, fiscal restraint has become the new, and perhaps, overdone, orthodoxy. Even countries like the US and the UK, where bond markets seem perfectly willing to finance deficits at very manageable funding rates, are seeing the political mood swing away from stimulus towards a more immediate assault on deficits.
While detailed plans are still rolling in, in many countries, fiscal retrenchments will subtract 1 to 2 percentage points from economic growth in each of the next two years. The US, for example, faces a roughly 1% drag from federal budget measures already in place, vs. a 1-3% GDP boost from stimulus in recent quarters, with more to come as states adopt additional belt tightening. The turn from stimulus to tightening will shave as much as 2% from 2011 growth in Canada.
That fiscal tightening, and the end to the one-time boost from inventory restocking, will be central to a deceleration from today’s global “V” into a flatter “U”-shaped advance, with just under 4% 2011 growth for world GDP, and on the order of 2½% for North America (Exhibit 4). Unlike Greece, Spain and Ireland, policymakers have room to go slowly enough to avoid the dreaded “W” of a renewed recession. But there are still implications for investment strategies in going from V to U.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
How Much Room For Disappointment? In the equity market, the difficulty is in discerning just what is being priced in for the next six quarters. Analysts’ bottom-up (First Call) consensus estimates for TSX earnings, showing growth of just over 20%, might be only slightly above reality, given the solid start to the year and the weak base of comparison from a year ago. It’s their call for a further, nearly equivalent profit jump next year that seems far too optimistic for an economy where nominal GDP looks to rise by no better than 5½% in 2011.
However, the bottom-up consensus is consistently biased on the upside, and even in bull markets it’s typical for earnings projections to come down to earth as the year gets under way. The market, therefore, already chops something off the analysts’ calls in deciding how much to pay. Year-ahead (i.e. 2011) forward earnings yields (relative to analysts’ consensus) are in fact below the historical norm for that far out (Exhibit 5), suggesting that investors have taken a larger-than-normal haircut off the consensus in valuing Canadian equities.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
8
Exhibit 5. Earnings Yield Leaves Room For Misses
0
1
2
3
4
5
6
7
8
9
TSX Yr-Ahead Earnings Yield(%)
10-yr bond yields
Today Average, ('87-date)
%
Source: Thomson Reuters.
So much so that earnings growth could be about half the consensus projection and in line with our macro-based top-down view (i.e. closer to 10%) and still leave forward earnings yields at roughly the historical norm. Note that bond yields are also below the historical average, so investors should, in fact, bid down comparable earnings yields on stocks.
All told, then, equities are already discounting a much weaker year ahead than analysts, and might therefore crawl higher over that period. Best bets, therefore, are for sluggish gains, rather than an outright bear market. Looking across all cycles since 1958, Canadian equities have typically seen a deceleration after the first rate hike, averaging a roughly 4% return in the six months after an initial Bank of Canada (BoC) move, vs. a double-digit return in the preceding six months. And stocks in Canada have become much more sensitive to overseas equities than was the case in prior decades (Exhibit 6), leaving them vulnerable to adverse news on economic developments in countries with deeper fiscal adjustments ahead.
Exhibit 6. Rising Canadian Equity Market Correlation With Non-US Stocks
0%
20%
40%
60%
80%
100%
120%
Jan-90 Jan-95 Jan-00 Jan-05 Jan-10
12 month moving correlation, %
(44% avg)
(83% avg)
Source: MSCI/Barra Total Return Index, CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
9
We can also learn a lot about what investors are now assuming by looking at yield curves. Fed fund futures, for example, already price in no hikes in 2010. We’ve long shared that view, and in the wake of the latest employment shortfall, are pushing our first rate hike back another quarter, into late Q2 2011. Note that America’s employment rate is still miles below where Canada’s stood when the Bank of Canada launched its 2010 tightening cycle (Exhibit 7). Still, a no-rate-hike expectation in the futures market leaves a wide range of plausible assumptions for growth, given how much slack there currently is in the economy, and the inability to price in an outright rate cut.
Exhibit 7. Employment Rate: US is a Mile Behind
57
58
59
60
61
62
63
64
65
Jan-03 May-04 Sep-05 Jan-07 May-08 Sep-09
Canada US
% of working age* population
*15 yrs and older for C da; 16+ for US
Source: Statistics Canada, US Bureau of Labor Statistics
More telling is the fact that north of the border, Canadian OIS contracts are priced for a 1% overnight rate by December. That would allow for the Bank of Canada to skip two rate decision dates over that period, an even more dovish outlook than our sub-consensus forecast for a 1.25% rate that includes a pause in December (Exhibit 8). Since the Bank would likely continue to tighten if Canada’s growth rate remained above its estimate of the non-inflationary potential (i.e. 2% or higher), it appears that equity markets are already cushioned for a substantial slowing from the first quarter’s over-6% pace. Equities therefore have room to rally, and bonds to sell off, if growth in Q2 matches our 3½% projection.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
10
Rate Hikes And Canadian Households With all of the pressure points globally, just as equities are likely to move only sporadically higher, we face some corresponding choppiness in fixed income markets as investors price in, then price out, additional rate hikes. But the broad direction in Canada’s bond market through 2011 is towards higher rates and a flatter yield curve.
The Bank of Canada’s last published forecast for the Canadian economy, released in April, would be consistent with a fairly rapid course of tightening. At that time, it saw the Canadian economy back at its full, non-inflationary potential output by the second quarter of 2011, which would typically entail taking overnight rates to at least 3½% over that period.
But since then, the Bank’s message has been muddied by a correction in both equities and commodity prices, one sufficient to at least leave it with some doubts about the appropriate pace of future hikes. If, as we expect, a decelerating global economy dents Canadian export growth materially, the need for rate hikes to moderate growth and inflation will be less pressing, as the slower growth path leaves the economy short of its non-inflationary potential right through 2011.
Moreover, the Bank will find that a smaller dose of tightening is sufficient to becalm, but not crush, Canadians’ demand for consumer goods and housing. A dampened wealth effect from housing will contribute to that. Using an IMF model, we find that house prices are already some 14% above “fair” value based on economic fundamentals (Exhibit 9). Rising rates, the new supply coming from an upturn in housing starts over the latter half of 2009, and tighter standards for CMHC insurance will combine to cool prices. A 5-10% correction is likely through 2011, one that will still leave only a small fraction of Canadians under water relative to their purchase prices, and an even smaller share of houses with negative equity.
Exhibit 9. House Prices Overshooting
Estimated deviation of Average House
Prices from Fair Value
-20
-10
0
10
20
30
40
50
60
2008 2009 2010
'000s
14.0%
As of April 2010
20.7%
17.4%
13.2%
13.0% 11.7
%
8.6%
BC ALTA MAN/SASK
QUE ONT ATL
Estimated deviation of Average House
Prices from Fair Value
-20
-10
0
10
20
30
40
50
60
2008 2009 2010
'000s
14.0%
As of April 2010
20.7%
17.4%
13.2%
13.0% 11.7
%
8.6%
BC ALTA MAN/SASK
QUE ONT ATL
Source: IMF, CREA and CIBC World Markets Inc.
Note that the ratio of sales to listings has already turned higher, typically a leading indicator of a softening in prices. We estimate that the housing wealth effect has been adding about a half-percent to the recent pace of consumer spending growth, which will disappear as prices level off and slowly retreat.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
11
That said, talk of a crash in domestic demand under the weight of excessive household debt burdens looks to be overstated. True, debt has reached a record level of nearly 1.5 times personal income. But it has been on a rising trend for more than a decade as the costs of servicing a given volume of debt have declined. The ratio of debt service to after-tax income looks well manageable at present (Exhibit 10).
Exhibit 10. Debt Service Burden
6.0
7.0
8.0
9.0
10.0
11.0
89 91 93 95 97 99 01 03 05 07 09
Effective interestrate on debt:6.3%
Effective rate:5.2%
% of pdi
6.0
7.0
8.0
9.0
10.0
11.0
89 91 93 95 97 99 01 03 05 07 09
Effective interestrate on debt:6.3%
Effective rate:5.2%
% of pdi
Source: CREA and CIBC World Markets Inc.
With export’s contribution to growth set to slow, the Bank of Canada will have to manage the pace of rate hikes so as to avoid a harsh deceleration by consumers. Given the high debt load, each 1% rise in rates will have a greater impact on consumer spending power. We therefore look for overnight rates to be no higher than 2.5% by the end of next year, with 10-year yields at roughly 4%, a shallower climb than consensus forecasts. That should leave real consumer spending growing at 3.4% this year, followed by a still-reasonable 2.7% gain in 2011.
The Medium Term Belongs To Canada While Canada will share in the global deceleration of 2011, and will be earlier than most in feeling the impact of monetary tightening, its medium-term prospects look brighter than most other industrialized economies. It was some 106 years ago that Wilfrid Laurier opined that while the US dominated the 19th century, the 20th century would “belong to Canada”. It didn’t, of course, quite work out that way, as forecasts with a 100-year horizon rarely pan out. But it might well be that, if not the 21st century as a whole, its second decade could be Canada’s to shine, at least among the industrialized economies of the West.
A Milder Hangover A key advantage is that the fiscal drag will come to an end sooner here than in Europe, the US or Japan. Canada has less gross debt, and much less net debt, than most others (Exhibit 11).
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
12
Exhibit 11. Canada’s Government Debt Burden The Least Onerous
0
50
100
150
200
250
Japa
nIta
ly
Greec
e UK
German
y
Unite
d St
ates
Cana
da
G-7 A
vg
Net Gross
2010 general govt debt-to-GDP ratio, %
Source: Statistics Canada and CIBC World Markets Inc.
While an earlier rate hike cycle could prevent such a growth differential from showing through in 2010-11, Canada will have a longer-term advantage in dealing with a much lighter burden from fiscal restraint. Canada’s current federal deficit of 3% of GDP (or 5% including the provinces) pales next to double-digit deficit-to-GDP ratios for national governments in the US and the UK. The result is that if each country aimed to stabilize its debt-to-GDP ratio at 45%, Canada would require a retrenchment of less than 3% of GDP, while others would need fiscal cuts several times larger (Exhibit 12). Moreover, while Canada’s short rates will top those of other countries in the near term, long-bond yields could be lower than elsewhere, given the country’s unquestioned AAA rating.
Exhibit 12. Size Of Fiscal Cuts Needed To Stabilize Net Debt-to-GDP Ratio
% of GD P
0
2
4
6
8
10
12
14
Japa
n
Unite
d St
ates UK
Gre
ece
Italy
Ger
man
y
Canad
a
Advan
ced
G-20
Econ
omies
Source: IMF and CIBC World Markets Inc.
The other hangover from the 2008-09 recession is that the world’s banks are still sitting with much less capital than regulators are likely to demand. But Canada’s banks are already better capitalized (Exhibit 13), and have long lived with limits on leverage. While details are still forthcoming, and changes are coming in the definitions used to calculate capital adequacy, the upcoming regulatory regime change should impose fewer restraints on lending growth in Canada than elsewhere given that stronger starting point.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
13
Exhibit 13. Canada’s Banks Well Capitalized By International Standards
6
7
8
9
10
11
12
13
Canada UK US Euro Area OtherMatureEurope
Average Tier 1 Capital Ratio, %
Source: CIBC WM, IMF
Source: IMF and CIBC World Markets Inc.
Johnny Canuck Shows Potential Attaining full employment faster will colour the near-term outlook, but for the decade as a whole, the other key is the trend growth rate in the economy’s longer-term non-inflationary potential. That sets the speed limit on how fast the Bank of Canada will let the Canadian economy advance without judging it as excessively inflationary.
In that regard, the Bank’s current estimate of the elbow room for non-inflationary growth, which allows for only a 2% longer-term pace, is likely to prove too conservative. The IMF puts the country’s initial output gap at about a half-point wider than the Bank’s estimate. If inflation doesn’t heat up, the Bank is always willing to adjust its output gap estimate to be in line with that evidence.
Once full employment is reached, the economy’s non-inflationary speed limit is tied to growth in working age population and productivity per worker. Demographers are concerned about an ageing work force that will slow growth ahead, but Canada is well-positioned relative to other mature economies. Japan is already seeing labour force shrinkage, and is ill-positioned to attract immigrants given language barriers and cultural homogeneity in its existing population. Fueled by immigration to a multi-cultural society, Canada’s economically active population is still set to grow faster than that of the US or Europe (Exhibit 14).
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
14
Exhibit 14. Projected Growth In Economically Active Population, 2010-2015
-4
-3
-2
-1
0
1
2
3
4
5
Canada UnitedStates
WesternEurope
Japan
%
Source: International Labour Organization and CIBC World Markets Inc.
Immigration also has a side benefit, in terms of helping Canada make inroads into some of the world’s faster growing developing-economy markets. Research across countries has identified that bilateral trade tends to be enhanced between countries in response to the movement of people from one to the other. Business and cultural ties to the home country can facilitate the movement of goods, a trend that appears evident in the Canadian data. Continued in-migration from East Asia and South Asia should help build Canada’s export prospects in these fast-growing markets.
Where Canada’s report card has suffered is on squeezing out more output per worker. The blame has been placed, in part, on sub-par business investment in productivity-enhancing capital equipment. On that score, there are at least some reasons to expect improvement ahead. Capital spending plans are recovering from their recessionary malaise, and corporate Canada is carrying less debt than its US counterpart, leaving more room to add leverage to finance those plans. Governments have done their part to encourage such spending, with corporate tax rates headed below those in all of the nation’s major developed-economy competitors (Exhibit 15).
Exhibit 15. Competitive Corporate Taxes Should Support Investment & Productivity Growth
20
25
30
35
40
Japa
nUSA
Fran
ceIta
ly
German
y UK
Canad
a
projected corporate tax rate, 2012 (%)
Source: Finance Department of Canada and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
15
Productivity, which focuses on the volume of goods produced per hour, doesn’t tell the whole story in terms of income and wealth. In the past decade, volume gains were supplemented by an improvement in the global market value of the goods that Canada sells to the rest of the world (particularly commodities), relative to what it imports (consumer goods) (Exhibit 16). Even including the setback from softer energy and metal prices during the recent global recession, those terms-of-trade gains accounted for about a third of Canada’s domestic income growth since 2002. That trend almost certainly has further to run given the rising needs of dynamic resource-hungry emerging markets.
Exhibit 16. Canada’s Terms Of Trade And Important Source of Income Growth
Sources of Increase in Incomes Since Q402
Domestic Forces (ie.
productivity & work
force growth),
10.4%-pts
Terms of Trade, 6.3%-pts
80
90
100
110
120
130
140
Mar-9
8
Mar-0
0
Mar-02
Mar-0
4
Mar-0
6
Mar-0
8
2002=100
Terms of Trade Sources of Increase in Incomes Since Q402
Domestic Forces (ie.
productivity & work
force growth),
10.4%-pts
Terms of Trade, 6.3%-pts
80
90
100
110
120
130
140
Mar-9
8
Mar-0
0
Mar-02
Mar-0
4
Mar-0
6
Mar-0
8
2002=100
Terms of Trade
Source: Statistics Canada and CIBC World Markets Inc.
The Bottom Line CIOs and other investors have been shifting funds out of risky assets in recent weeks, pointing to concerns about sovereign debt and global growth. While we see those fears easing off in the months ahead in the absence of an outright sovereign default, the drag from fiscal tightening could contain risky assets to muted gains in choppy markets over the next few quarters.
Longer-term fundamentals, however, remain favourable for Canada’s risky assets. The country’s resource endowments, resilient financial system and favourable demographics relative to other G-7 nations make it an economic contender looking out over a five-year horizon. Another notable positive is in the healthier state of public and corporate sector balance sheets. These factors are no iron-clad recipe for national success in the near term, but do mean Canada is better-positioned than many of its competitors to deal with the challenges of the upcoming years. And where economic growth goes, corporate earnings, dividends and other rewards for investors are likely to follow.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
16
Portfolio Strategy and Quantitative Research Peter Gibson, (416) 594-7194 Jeff Evans, (416) 956-3250
Introduction The global economy is dangerously close to a debt crisis and western governments are doing everything possible to avert such a crisis. Concurrently, the enormous size of the emerging economies, based on population and their potential to alter the global economic landscape, eclipses anything ever witnessed historically. Emerging economy growth, however, is not yet self-sustaining and the entire global economy still depends on the urgent need to ensure that the U.S. economy, the U.S. consumer and U.S. real estate are all stable. U.S. debt levels, as well as recent weakness in the housing market and U.S. employment, suggest that the U.S. is not yet out of the woods. It is imperative that the U.S. bond yield stay in the range of 3% to 3.2% and that tightening by the Federal Reserve be delayed as long as possible so that housing inventories have time to fall and corporate profitability has sufficient time to recover.
We believe that the U.S. economy can and must muddle along. The U.S. will record a modest rate of economic growth thanks to an artificially low bond yield. Great returns from successful investing will continue to depend on tactical asset allocation decisions and every critically important change to stock and bond exposure will continue to be driven off the level of 10-year U.S. treasury yields. Investors must be far more active, more trading-oriented and more aggressive with respect to asset allocation. For CIOs, the asset allocation and currency calls have never been more complex or more important. In this environment, all asset class returns tend to fall to low single digit levels on average. Volatility and risk premia tend to soar. These challenges tend to persist until the financial system collapses or the debt levels recede, which can be many years.
Canada is very well positioned as long as the U.S. bond yield is close to the recent 3% level and S&P 500 ROE is stable, thereby implying a stable U.S. economy. Our financial sector is stronger than the rest of the world and the energy and materials sectors should continue to benefit from emerging economy growth while inflation and interest rate risk remains paradoxically low.
We recommend overweighting stocks since S&P 500 ROE is stable and bond yields are toward the lower end of our critical important range. Furthermore, the U.S. Federal Reserve can postpone tightening for the foreseeable future. At the same time, we expect a rebound in oil prices driven by current emerging economy growth. Canadian banks also continue to post strong profit growth and although profit growth is expected to be weaker over the next 12 months, growth is still positive. Base metals companies are recording an improvement in ROE and the gold companies continue to benefit from secular gains in the commodity. The financial, energy and materials sectors represent 78% of the TSX market cap and Canada is benefiting from low U.S. rates and relatively favourable commodity prices resulting from emerging economy growth.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
17
Expectations For The Remainder Of 2010
In part, due to the recent stock market correction, our year-end 2010 targets represent a very attractive rate of return of 10.29% for the TSX and 12.28% for the S&P 500 over the next six months (Exhibit 17). Our outlook is based on the fact that the 10-year U.S. Treasury bond yield is currently 3.22%, while the ceiling is in the range of 3.7-3.9%. In addition, S&P 500 ROE appears to be holding at 19.57%, although it shows no evidence of growth. The Fed is in no hurry to tighten based on the still weak U.S. housing market. The longer the U.S. yield curve can remain steeply positively sloped, the more time that the U.S. banking system has to recapitalize.
Exhibit 17. Targets
Recent 2010E TSX 11,666 12,307 - 12,867 Earnings Actual 640 Ours $634 Top Down P/E (x) 18.2x Ours 19.9x P/E Median(Wtd) & Street Fwd GPS 14.46x (19.66x) 12587/$768 (street) = 16.4x Trail ROE m(w) & Street Fwd ROE 8.89% (11.6%) GPS Fwd 0.29 (0.32) ROE2qF (14.63) 14.4 S&P 500 1,091 1,225 Earnings Actual 65 Ours $68 Top Down P/E (x) 16.8x Ours 18.0x P/E Median(Wtd) & Street Fwd GPS 15.2x (16.4x) 1225/$72 (Street) = 17.0x Trail ROE m(w) & Street Fwd ROE 14.53% (19.57%) GPS Fwd 0.07(0.06) ROE2qF (19.47) 19.38 Canada T-Bills (%) 0.59 0.6 10-year Bond Yields (%) 3.52 4.1 US T-Bills (%) 0.08 0.5 10-year Bond Yields (%) 3.22 4.1 WTI Oil (US$/bbl) 74.2 95 Gold (US$/oz) 1,230 1,300 C$/US$ (Trading Range) 0.9688 0.95-1.02 Source: CIBC World Markets Inc., Bloomberg
Our TSX top-down earnings forecast for year-end is $634, well below the $768 Street forecast. This would be consistent with the current rate of earnings growth, but not with the bottom-up Street forecast. The anticipated and recently witnessed rebound in earnings for the energy and materials sector could make the Street forecast achievable if global markets can avoid any more exogenous crises for now. If so, then the TSX P/E would be expected to decrease to 16.4x from 16.75x compared with 17x for the S&P 500. If we could be sure that we would remain below the crucial bond yield ceilings (3.9%), then the TSX has considerably more potential for strong returns than the S&P 500.
We also believe that the oil price will rebound to US$93-95/Bbl as a result of emerging economy demand and the modest U.S. recovery. As long as the U.S. economy is stable, we believe gold will reach US$1300/oz by year-end. If, however, a Greece default occurs that stands to spread to Spain, Ireland or France and Germany, or if the Fed is forced to tighten due to a bond yield level in excess of 3.9%, or in the face of other geopolitical risk, we believe that the gold price could easily achieve levels in the range of US$1500-2000/oz.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
18
Asset Allocation We recommend being overweight equities until we have indications that the equity cycle is over. Specifically, we would be looking for 10-year U.S. Teasury yields to exceed the range of 3.7% to 3.9%, especially if S&P 500 ROE was falling and/or the U.S. Federal Reserve was tightening. Since the global economy is still trying to recover from recession, it is likely that an eventual rise in S&P 500 ROE and bond yields would lead to a rise in short-term rates. Even at that point, if short rates increase and long rates fall proportionately, then we would view that favourably as well.
Of greater near-term concern, however, is the fact that there is an underlying weakness to the U.S. economy, and the European crisis is not yet resolved. There remains a very significant possibility that the crisis in Greece leads to a default and continued concern over the survivability of the Euro, as well as the distinct possibility of another global liquidity crisis. The ECB has frequently cited concern over the risk of inflation. These concerns are most likely moral suasion, as significant increases in debt levels are necessary to buy up debt in regions facing default. Inflation fears are otherwise misplaced.
Our Canadian conservative asset allocation recommendations are predicated on a 12- to 18-month horizon (Exhibits 18 & 19). We would like to increase our equity weighting, but we need to see some resolution in the European crisis and a recovery in U.S. real estate prices and S&P 500 ROE. TSX ROE is currently 11.60% and rising at an impressive 0.52 standard deviations on a weighted basis. The median TSX ROE is 8.89% and is rising at a more subdued 0.23 standard deviations. The one-quarter forward Street estimates for the TSX indicate a respectable 0.32 standard deviation growth rate. TSX ROE should rise from the recent 11.6% level to the 14.6% to 14.9% level over the next three quarters. Our 430 company Canadian small cap index is recording a +0.02% ROE level, which may not be surprising for micro cap stocks, but it is rising slightly at 0.17 standard deviations.
Exhibit 18. Recommended Asset Mix
Tbills5%
Equities50%
Bonds45%
Source: CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
19
Exhibit 19. Recommended Asset Mix
Recommended Asset Mix Allowable range Equities 50% Equities/Bonds 40-60% Bonds 45% Tbills 5% Tbills 0-30% Source: CIBC World Markets Inc.
Our Canadian Tactical asset mix is based on a 3- to 6-month investment horizon. The more aggressive equity exposure is the result of indications of a rebound in index prices for the TSX and the S&P 500, as well as an upward implied move in bond yields (Exhibits 20 & 21).
Exhibit 20. Canadian Tactical Asset Allocation
Tbills0%
Bonds35%
Equities65%
Source: Company reports and CIBC World Markets Inc.
Exhibit 21. Canadian Tactical Asset Allocation
Recommended Asset Mix Allowable range Equities 65% Equities/Bonds 30-70% Bonds 35% Tbills 0% Tbills 0-40% Source: Company reports and CIBC World Markets Inc.
The international asset mix is comprised of a 15% recommended exposure to gold (Exhibits 22 & 23). We have been recommending gold for eight years, initially because of an anticipated devaluation of the U.S. dollar reserve currency, and later because of anticipated renewed deflation fears.
Gold is still favoured longer term, though it remains one of the most volatile asset classes historically. We also have a strong preference for Canadian equities over U.S. equities and a view that as long as the U.S. economy is stable, the Canadian dollar should appreciate further. Our asset mix models should tell us if the equity cycle ends in a more traditional way later this year or, if we are emerging from recession, the economic and equity cycles can last for several years. In the latter case, we would expect the Canadian dollar to trade between $1.00 and 1.05, and $1.05 to 1.10 in 2011 and 2012, respectively, but this would be unusual.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
20
Finally, geopolitical risk remains very elevated and our uninspiring weights in this region reflect the better perceived opportunities in Canada and less currency risk in the United States.
The significance of a possible Greek default is most relevant to the likelihood of a larger crisis in the region due to a contagion affect. The external debt of Spain and Ireland represent a larger concern for the survivability of the Euro if the Greek situation cannot be stabilized. Rarely when countries have a public debt to GDP ratio in excess of 93% can default or effective default be avoided. The ECB role in buying Greek debt is critical. The Bank for International Settlements estimates that French and German banks have nearly one trillion dollars of exposure to the residents of Greece, Portugal, Ireland and Spain. Ultimately, the decision by the ECB to intervene is a decision to avert a potential bank crisis while taking a step toward centralizing banking through bailouts. In 2003, we predicted that the Euro would cease to exist by 2010 and today, we remain very uncertain about its survivability.
Exhibit 22. International & Gold Asset Allocation
Japan, 9%
Germany, 4%
France, 4%
UK, 9%
Asia, 4%
U.S. Equities, 70%Gold, 15%Bonds, 35%
Canadian Equities, 35%
U.S. & Initernatiional Equities, 15%
Source: Company reports and CIBC World Markets Inc.
Exhibit 23. International And Gold Asset Allocation
U.S. & International Equities Gold 15% U.S. Equities 70% Bonds 35% Asia 4% Canadian Equities 35% UK 9% U.S. & International Equities 15% France 4% Germany 4%
Japan 9% Source: Company reports and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
21
Exhibit 24 – Global Benchmark Weights
Benchmark Weights MSCI% U.S. 41.95 Japan 8.92 UK 8.69 Canada 4.21 France 3.99 Germany 3.15 Asia (ex-Japan) 8.46 Others 20.63 Total 100 Source: Company reports and CIBC World Markets Inc.
Exhibit 25. 3-month and 12-month Total Returns
Total Returns 3-month 12-month S&P TSX -2.16 15.44 Canadian 10-year Government Bond 1.89 4.13 Canadian 3-month t-bills 0.09 0.49 S&P 500 -4.80 17.53 U.S. 10-yr Government Bond 4.42 9.26 U.S. 3-month Tbills 0.07 0.36 DOW Industrials -4.24 18.33 Nasdaq -5.01 23.54 S&P 500 C$ -4.16 7.59 Source: Company reports and CIBC World Markets Inc.
Exhibit 26. S&P 500 and TSX Price
4000
6000
8000
10000
12000
14000
16000
Jan-
07
Apr-0
7
Jul-0
7
Oct-0
7
Jan-
08
Apr-0
8
Jul-0
8
Oct-0
8
Jan-
09
Apr-0
9
Jul-0
9
Oct-0
9
Jan-
10
Apr-1
0
400
600
800
10001200
1400
1600
1800
S&P TSX (RHS) S&P 500 (LHS)
Source: Company reports and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
22
Exhibit 27. S&P 500 and TSX ROE
91113151719212325
Feb-
07
Aug-
07
Feb-
08
Aug-
08
Feb-
09
Aug-
09
Feb-
10
S&P 500 S&P TSX
Source: Company reports and CIBC World Markets Inc.
Exhibit 28. Relative Total Return
0.2
0.4
0.6
0.8
1
1.2
1.4
Jan-
07
Apr-0
7
Jul-0
7
Oct-0
7
Jan-
08
Apr-0
8
Jul-0
8
Oct-0
8
Jan-
09
Apr-0
9
Jul-0
9
Oct-0
9
Jan-
10
Apr-1
0Canada Equities/Bonds US Equities/Bonds
Source: Company reports and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
AUSTRALIA 7.4 -0.12 13.52 1.84 3.83 -3.87 201 Source: Company reports and CIBC World Markets Inc.
Core And Trading Portfolio
Recommended Sector Weights There are a myriad of ways to set sector weights. For example, our GPS (global portfolio system) has well over 100 criteria for value, growth, capital structure, operating characteristics and trading /option data. The recommended weights depend entirely on the investment style and investment horizon of the client.
The portfolios (see Appendix) of 48 stocks are designed with the goal of being relatively large cap and as diversified as stock fundamentals allow. The name list is the same for both portfolios, but they involve differences in important underlying assumptions. The purpose of these portfolios is simply to show which stocks are relatively superior to their peers and the relative emphasis on sectors while remaining fairly close to the benchmark sector weights.
These portfolios are what we refer to as core plus trading. The core names are more fundamentally attractive, relatively larger names. In order to be included in the core, the company must have an index weight of over 0.07%, an ROE level greater than 5%, moderate or stronger trailing ROE growth, forward ROE growth and a calculable probability of outperforming the TSX.
The trading component by contrast requires only a positive ROE level, forward and trailing ROE growth, but requires favourable absolute price momentum and favourable relative price momentum based on our trading techniques. If a name qualified for both the core and trading portfolios, it is identified as C+T.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
24
Exhibit 30. Summary Of Core + Trading (C+T) Portfolio Weights Vs. Benchmark Weights
Total Weight: Benchmark Weight: Energy 22.33% 26.15% Materials 19.78% 20.43% Industrials 6.94% 5.44% Consumer Discretionary 2.07% 4.51% Consumer Staples 0.72% 2.96% Healthcare 0.00% 0.46% Financials 41.63% 31.39% Info Tech 1.02% 3.02% Telecom 4.20% 3.97% Utilities 1.31% 1.69% Source: Company reports and CIBC World Markets Inc.
Portfolio A (see Appendix) companies qualify for the portfolio based on their relative weights (relative market capitalization). There are no constraints on these weights and, therefore, they are more reflective of the weighted average fundamental characteristics of the various sectors (Exhibit 30). For example, the energy sector is 22.33% of this portfolio by weight relative to the 26.15% weight of this sector in the TSX. In recent months, this weight has increased significantly as fundamentals have improved.
In the financial sector, the large banks with their significant rate of profit growth have caused the sector weight to reach 41.63% of the portfolios. Bank of Nova Scotia (BNS–SP) and Bank of Montreal (BMO–SO) are both core and trading recommendations. This significant financial sector overweight reflects the strong fundamentals, but real institutional portfolios are unlikely to be unconstrained like this.
Portfolio B (see Appendix), therefore, overlays two important techniques. First, we increase or lower the recommended weight of every stock in the portfolio based on our price momentum ranks. This facilitates better timed exposure to core fundamental names and sets the trading names to their appropriate weights based exclusively on price momentum. Finally, we overlay a single stock weight limit (SSL) with a minimum single stock weight of 0.5% to a maximum single stock weight limit of 7%. Portfolio B, therefore, should outperform portfolio A over time due to changes in timing, but may give up some incremental performance due to limits on single stocks weights and better diversification. Both portfolios, however, provide indications of fundamental sector preferences (Portfolio A) and timing differences (Portfolio B) by comparing the precise, mathematically derived sector weights with the benchmark weights.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
25
Exhibit 31. Summary Of Core + Single Stock Limit (SSL) Tilt Weights Vs. Benchmark Weights
Total Weight: Benchmark Weight: Energy 26.48% 26.15% Materials 19.09% 20.43% Industrials 5.26% 5.44% Consumer Discretionary 2.84% 4.51% Consumer Staples 1.09% 2.96% Healthcare 0.00% 0.46% Financials 36.05% 31.39% Info Tech 1.05% 3.02% Telecom 6.37% 3.97% Utilities 1.78% 1.69% Source: Company reports and CIBC World Markets Inc.
There are some good core names outside of the financial, energy and materials sectors, but the concentration in these three sectors is a critically important issue for investors.
Background: A U.S. Economic Recovery Is Still Essential Since the market low of 1998, the S&P 500 price level is essentially unchanged, yet the market has recorded five of the largest rallies and collapses in the last 150 years. Even from the lowest point the S&P 500 witnessed in 1998, the index has only averaged a 2.97% total return over the last 12 years. Yet, in succession, the market rallies and declines were +57%, -50%, +94%, -57%, and +84%. Each stock market rally coincided with a collapse in bond prices and each stock market collapse coincided with a huge rally in bond prices. This phenomenon has only been witnessed on two occasions in the last 150 years (The Long Depression and the Great Depression). This type of market behaviour only occurs during periods of debt crisis and/or deflation. It is a game changer.
Truth be told, we have been living on the edge of a global debt crisis. The goal is to postpone the debt crisis by any and every means possible until an energy-related, productivity-driven technological breakthrough allows us to grow out of debt. Until that happens, tactical, shorter-term, asset-mix decisions and stock trading systems are essential to generating even a respectable return.
Exhibit 32. S&P 500 P/E And Bond Yield Positive Correlation
0
1
2
3
4
5
6
7
8
0
200
400
600
800
1000
1200
1400
1600
1800
10 year US bond yield S&P 500
0
5
10
15
20
25
30
35
40
1871
1877
1883
1889
1895
1901
1907
1913
1919
1925
1931
1937
1943
1949
1955
1961
1967
1973
1979
1985
1991
1997
2003
Apr-0
6
Oct-0
6
Apr-0
7
Oct-0
7
Apr-0
8
Oct-0
8
Apr-0
9
Oct-0
9
Apr-1
0
Positive Bond Yield/Equity Correlation S&P 500 P/E (LHS) Monthly S&P 500 P/E levels from 2006 - present
T he Long Depression
The Great Depression
Entire period positive correlation as illustrated by U.S. bon d yields & stock prices since 1998
(Shaded region show only coincident falling bond yields and falling stock prices for calendar years) Source: CIBC World Markets Inc., Bloomberg
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
26
Exhibit 33. S&P 500, TSX Vs. 10-Yr U.S. Bond Yields
Beware The Bond Yield Spike/ Currency Collapse When bond yields exceed the critical ceiling and the currency is falling, a hot capital exodus is gaining momentum. This combination implies that bond investors are fleeing those countries’ debt markets. If the central bank does nothing to stop this, then bond yields tend to skyrocket and a debt crisis and economic crisis follow. Alternatively, if the central bank raises short-term interest rates dramatically, the rise in bond yields and collapse in the currency can be halted, but great economic hardship and austerity tend to follow. Sometimes the resulting improvement in productivity growth leads to an economic recovery.
When New Debt Is Used For Bailouts, It Can Compromise Future Growth Usually, when public debt to GDP levels exceeds 90%, it is difficult or impossible for a country to avoid default. Were it not for an ECB bailout of Greece, defaulting would be their immediate fate (Exhibit 34). Spain and Ireland are in serious potential crises, more serious than Greece because of huge external debt burdens. The risk to the Euro and the core Euro zone nations is that their bailouts might compromise the core countries to the Euro. If the current crisis results in a contraction of economic growth in broader Europe and rising bond yields and credit spreads, then the existence of the Euro itself is threatened and a global liquidity crisis is a possibility.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
27
Exhibit 34. Greece CDS USD SR 5yr Corp
Source: CIBC World Markets Inc.
The U.S. Safe Haven Artificially Low Bond Yield Strategy
Of course, there is no prospect of a global recovery if the U.S. consumer is lost and, therefore, the U.S. economy. The harsh reality is that U.S. government debt at all levels is already 100% of GDP and so is consumer debt. Were it not for the fact that the U.S. is the relative “safe haven” and global reserve currency, thereby allowing the U.S. to “credit ease” in 2009, then the U.S. itself would be facing an imminent debt crisis.
1850 - present 1980-1998 1998-present U.S. T-bills 4.59 6.61 3.07 U.S. bonds 4.88 11.64 5.95 U.S. stocks 8.70 15.30 2.97 Canadian Stocks 9.38 9.01 9.10 Source: CIBC World Markets Inc.
As bond yields and stock prices became positively correlated in 1998, our investment world almost completely changed. Not only did all asset class returns begin to fall to record low average levels over the next 12 years, as indicated by Exhibit 35, but U.S. bonds outperformed U.S. stocks, on average, and a paradigm shift occurred in perceived risk and with it a move to higher credit spreads. For only the sixth time in over 150 years and the third time since 1920, the cumulative rate of return on stocks stalled out over an extended period of time.
Exhibit 36 illustrates the 150- year historical relationships between bond yields and stock prices and relates this to rates of return for stocks, bonds and T-bills. For example, the inflationary mid to late 1960s and 1970s show a consistent pattern of rising bond yields and rising stock prices. By contrast, the deflationary 1883 and 1893 time frames, and the 1930s, are observed under the category of stock prices down and bond yields down. The years 2000, 2002 and 2008 are
Credit default swaps spreads in Greece rose to truly crisis levels and the risk of default remains very high.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
28
also found here. The highest average rates of return and the largest number of occurrences are the more “normal” stocks prices up/ bond yields down environment. This combination is also common to the early stages of new economic cycles.
Exhibit 36. Asset Class Observations in the U.S.
Stock Up Yield Up Stock Up Yield Down yield < 4% 4% < yield <7% yield > 7% Total yield < 4% 4%< yield < 7% yield > 7% Total T-bills 2.68 4.94 7.86 4.39 3.05 5.61 8.61 4.64 Bonds 1.19 0.88 1.30 1.09 4.89 10.18 26.55 9.01 Stocks 21.41 17.03 19.39 19.43 22.90 18.86 21.98 21.03 # of observation 22 19 7 48 29 27 5 61 Year 1889, 1891,
Most relevant to CIOs has been the overarching significance of calculating bond yield “floors and ceilings” and selling stocks in favour of bonds at the “ceilings” and selling bonds in favour of stocks at the “floors”, especially if index profitability (ROE) is rising (Exhibit 37). This is the key to our forecasts of stock and bond returns. During the last year, we have witnessed our estimated ceiling on U.S. bond yields fall from the range of 4.3% to 4.6% to 4.07% to less than 3.9%.
Fortunately for North America, the Euro zone crisis caused an inflow of safe haven seeking capital that drove U.S. bond yields down to 3.2%, establishing a lower average level of bond yields, which is crucial to home prices and forestalls any urgent need for Fed tightening. This gives the U.S. economy more time to recover as long as the offshore crisis can be contained.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
29
Exhibit 37. U.S. 10-year Bond Yield Floors And Ceilings
0
20 0
40 0
60 0
80 0
100 0
120 0
140 0
160 0
180 0
1994
1994
1995
1995
1996
1996
1997
1997
1998
1998
1999
1999
2000
2000
2001
2001
2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
2009
2010
2010
2011
2011
2012
0
1
2
3
4
5
6
7
8
9
SPX In dex USGG10YR Ind ex
199 5 ceil in g
19 97 cei li ng200 0 ceil in g
20 03 ce ili ng (5.9% )
5 .2 % ceil in g4.8% ce ili ng
3.5% Exce ss deb t floo r
4% 19 97 flo or
2.0% Ul timate floo r
0%
Term Structure
4 .6 %4 .3 %4 .0 7%
3.0% Desired lon g te rm avera ge
2 002 ce il ing
200 9 cei lin g (4.3-4 .6 %)
3 .7 -3.9% Dan ger ran ge
+0.67
Positive Correlation
+0.64 +0.20Real Estate Bubble
-0.34+79%
inc volatility -41% +174%
Correlation & Volatility
S&P 500 Buy & Hold since 1998 low 1.44% pa
+57% -50% +94% -57% +84%Bond Buy & Hold 6.64% pa
Source: CIBC World Markets Inc., Bloomberg
Significance Of The Bond Yield Ceiling The ceiling represents the level of 10-year U.S. treasuries that signals great valuation risk to stocks and real estate prices. This is especially true if S&P 500 ROE is falling and/or the U.S. dollar is falling at that point. It is the level of bond yields which we believe forces the Fed to tighten unless a non-North American crisis forces yields down immediately. Of course, a crisis at that point may drive stock prices lower as well. At present, the 10-year U.S. treasury yield is 3.2% and sufficiently below the ceiling of 3.7% to 3.9%. S&P 500 ROE is stable at a very high 19.57%. Fortunately, the Fed is not tightening. The record stock market crashes of 2000-2003 and 2007-2009 were signaled by the combination of Fed tightening while the level of bond yields exceeded their ceilings of the respective periods and S&P 500 ROE was falling.
To summarize, we believe that it is the collective pressure of the global debt and currency market which dictates U.S. Federal Reserve policy. It is our floor/ ceiling analysis coupled with our ROE analysis of markets and currencies which determines unambiguously what the Fed can and must do at any time and how stocks and bonds will react.
Canada In A Global Context Canada occupies a very unique global niche. As long as the U.S. economy is stable, Canadian interest rates can be relatively low as a result of artificially low U.S. rates. Yet, because of emerging economy growth, we benefit from relatively strong commodity prices. This is unusual because strong commodity prices are usually associated with higher inflation expectations and higher interest rates, stable rates and higher commodity prices are very beneficial for the TSX since the energy and materials sectors represent about 46% of the TSX market capitalization and the interest rate sensitive financials represent another 31.5%.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
30
The potential for the Canadian dollar to rise vis-à-vis the U.S. dollar is significant. The real risk to the Canadian dollar in the shorter term is its link to the “risk bet”. Exhibit 38 illustrates the tendency for sharp selloffs in the Canadian dollar during economic crisis and/or recessions. This is common for most export-dependent currencies when the U.S. dollar strengthens for safe haven reasons. In general, we would expect the Canadian dollar to trade in successively higher ranges over the next several years, except when U.S. bond yields reach the 3.7% to 4.0% range, which would force the Federal Reserve to tighten.
Exhibit 38. C$/U.S.$ vs U.S. GDP yoy %
-15
-10
-5
0
5
10
15
20
25
0.6
0.7
0.8
0.9
1
1.1
Jan-2
2
Jan-2
7
Jan-3
2
Jan-3
7
Jan-4
2
Jan-4
7
Jan-5
2
Jan-5
7
Jan-6
2
Jan-6
7
Jan-7
2
Jan-7
7
Jan-8
2
Jan-8
7
Jan-9
2
Jan-9
7
Jan-0
2
Jan-0
7
C$/US$
US GDP yoy %
Source: CIBC World Markets Inc., Bloomberg
Corporate Profitability (ROE) As An Indication Of North American Economic Growth
Recent levels for the U.S. bond yield are favourable and imply that U.S. equities are undervalued relative to U.S. bonds. Sustainable gains in stock indices, however, depend on profit growth and a favourable level of bond yield. The direction of U.S. housing prices is a major determinant of consumer confidence, consumer spending and U.S. economic growth. During the 2003 -2007 speculative mania in housing and its subsequent collapse, the direction of housing prices was also profoundly important to ROE in the U.S. financial sector. Naturally, therefore, weakness in the U.S. housing sector has necessitated a return to a steeply positive sloped yield curve in the U.S. with the hope of restarting the U.S. housing cycle (or at least stabilizing it), as well as the urgent need for U.S. banks to re-liquefy and try to stabilize their balance sheets (Exhibit 39).
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
31
Exhibit 39. U.S. and Canada Financial Sector ROEs & U.S. Housing Index
4
6
8
1 0
1 2
1 4
1 6
1 8
Nov
-00
May
-01
Nov
-01
May
-02
Nov
-02
May
-03
Nov
-03
May
-04
Nov
-04
May
-05
Nov
-05
Ma
y-06
Nov
-06
Ma
y-07
Nov
-07
Ma
y-08
Nov
-08
Ma
y-09
Nov
-09
10 0
12 0
14 0
16 0
18 0
20 0
22 0
24 0
26 0
28 0
30 0
A v e-Ca n Med -Can Av e-US Me d-US US Hou sing Ind ex (Rad arLo gic)
A ve US
A ve CA
Source: CIBC World Markets Inc., Bloomberg
The crisis since 2007 is justification enough for the Fed to maintain the positively sloped yield curve for as long as possible, at least until financial sector ROE has time to recover. Clearly, though, if U.S. bond yields rise and the Fed is forced to tighten, there is still the possibility that higher short rates could cause long rates to fall. A tilting of the U.S. yield curve of this type also tends to benefit stocks as long as ROE is recovering (Exhibit 40).
Exhibit 40. U.S. and Canada Financial Sector ROEs & U.S. Yield Curve
0
2
4
6
8
1 0
1 2
1 4
1 6
1 8
2 0
Nov
-00
May
-01
Nov
-01
Ma
y-02
No
v-02
May
-03
Nov
-03
May
-04
Nov
-04
Ma
y-0
5
No
v-0
5
Ma
y-06
No
v-06
May
-07
Nov
-07
Ma
y-0
8
Nov
-08
Ma
y-09
No
v-0
9
-1
0
1
2
3
4
5
A ve-Can Med-Ca n Av e-US Med-US US Y ield Cu rve
Y ield Curve Slope
Inv erte d
+ slo pe + s lop e
Source: CIBC World Markets Inc., Bloomberg
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
32
S&P 500 And TSX ROE Rarely do we see TSX ROE record dramatically stronger growth than the S&P 500. Between 2003 and 2007, emerging economies pushed commodity prices higher and gave the TSX a vastly better rate of growth than the S&P 500. This same phenomena is being witnessed again in recent months. Our data indicates that weighted average TSX ROE was recently 11.62% and is rising at the impressive rate of 0.52 standard deviations. Forward Street estimates for TSX stocks rolled up to forward ROEs indicate a range of between 14.63% and 14.90% in the future. By contrast, S&P 500 ROE is currently 19.57% and shows no evidence of expected growth in the next two to three quarters.
Exhibit 41 clearly indicates far better internal profit dynamics for the TSX, with 98 of the 221 companies recording profit growth. These companies represent almost 61% of the TSX weight. By contrast, only 197 of the S&P 500 companies are recording ROE growth, representing only 39.22% of the S&P 500 market cap. Even more startling is the fact that the forward analyst earnings suggest only 169 companies, representing a mere 33.58% of the index weight, are expected to post ROE growth next quarter! All together, the weak recovery in U.S. ROE suggests that the Fed has a vested interest in sustaining the relatively low level of U.S. rates, yet the TSX is recording a phenomenal rebound in ROE. This is a very favourable combination for the TSX.
Exhibit 41. TSX And S&P 500 ROE Characteristics As of June 11, 2010
33.58% Financial, Energy & Materials (%) 87.66 77.87 81.53 30.23 Energy & Materials 39.64 46.4 60.29 Source: CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
33
Energy Sector ROE And Security International oil consumption has benefited from growth in India, but Exhibit 42 shows a stunning rise in consumption driven by China from the 1990s forward. Historically, the lagged year-over-year change in West Texas intermediate prices is very highly correlated with energy sector ROE. Not surprisingly, the year-over-year rise in oil prices is driven by a recovery in the GDP of the U.S., China and India.
Exhibit 42. Correlation: GDP & Oil
-5
0
5
10
15
20
25
30
35
40
45
Mar
-00
Jul-0
0
Nov
-00
Mar
-01
Jul-0
1
Nov
-01
Mar
-02
Jul-0
2
Nov
-02
Mar
-03
Jul-0
3
Nov
-03
Mar
-04
Jul-0
4
Nov
-04
Mar
-05
Jul-0
5
Nov
-05
Mar
-06
Jul-0
6
Nov
-06
Mar
-07
Jul-0
7
Nov
-07
Mar
-08
Jul-0
8
Nov
-08
Mar
-09
Jul-0
9
Nov
-09
-80
-60
-40
-20
0
20
40
60
80
100
120
USA China India Oil (US$/bbl - right ax is)
China
India
US
Oil
Source: CIBC World Markets Inc., Bloomberg
Oil And Energy Security If the rapidly growing emerging economies get into trouble, then some moderation of the upward pressure on commodity prices is possible. Without a major energy-related technological breakthrough, energy security and self-sufficiency are an extremely urgent problem. Two simple examples illustrate the leverage to emerging economy growth and the obvious need for energy alternatives. First, if China and India had as many cars per capita as the U.S., this would be roughly equivalent to adding two billion new cars to the world with all of the related resources depletion and environmental destruction (Exhibit 43).
US GDP growth ( annual %) China GDP growth (annual %) Indi a GDP growth (annual %) US GDP (current US$)
China GDP (current US$) India GDP (current US$)
Source: CIBC World Markets Inc., The World Bank Group
Finally, a comparison of GDP growth rates for China and India relative to the U.S. suggest that an energy squeeze is an ongoing concern.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
34
Second, Exhibit 44 provides an easy comparison of U.S. GDP and population. If, one day, China and India achieved the same ratio of GDP to population size as the U.S., then the GDP circle would completely obscure all of China and India, the middle east and most of western Europe.
Exhibit 44. BRIC Nations & U.S. Population, GDP And Imports/Exports
Sources: CIBC World Markets, CIA Wor ld Factbook. Image: GEBCO.net, Wikipedia
Source: CIBC World Markets Inc., CIA World Factbook. Image: GEBCO.net, Wikipedia
It has been estimated that at 85 million barrels per day (bpd) of consumption, oil reserves will be depleted in 30 years, but with new emerging economy consumption, oil demand, if unconstrained, would be expected to rise by 30-60%. In fact, it is possible that a variety of base metals will also become depleted as a result of the scale of emerging economy growth. Evidence supporting this possibility is seen in the fact that oil prices remained in the US$40 to $90 range per barrel during the 2008/2009 recession (depression).
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
35
Exhibit 45. U.S. Real GDP Growth, CPI yoy & Oil price yoy %
-10
-5
0
5
10
15
20
25
30
35
40
Jan-
74
Jan-
76
Jan-
78
Jan-
80
Jan-
82
Jan-
84
Jan-
86
Jan-
88
Jan-
90
Jan-
92
Jan-
94
Jan
-96
Jan-
98
Jan-
00
Jan-
02
Jan-
04
Jan-
06
Jan-
08
Jan-
10
- 100
- 50
0
50
10 0
15 0
20 0
25 0
30 0
W Ti oi l p ri ce y o y
C PI yoy
U .S . real GDP
C h ina N et Importer
R are ly Nega tive y oy
O bserve change in re lative pe rform ance
Source: CIBC World Markets Inc., Bloomberg
Conceptually, the path that China and India take to energy consumption per capita is crucial. For example, as China and India industrialize and GDP per capita grows, it would be preferred that these highly populous nations follow path A rather than path B (Exhibit 46). Path A would illustrate a clear focus on generating a higher GDP per capita relative to the energy inputs required to generate that standard of living–the direction of the highly energy-efficient Japan. Path B would suggest that far more energy consumption is occurring for the world’s two most populated countries—implying enormous upward pressure on commodity prices and probably severe global constraints.
Exhibit 46. Energy Consumption Rate Per Capita vs. GNP Per Capita
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
$45,000
0 2 4 6 8 10 12 14 16 1 8
Thousandsk Wh per capita
GD
P p
er c
apit
a
Energy Consumption vs GDP
Japan
US
UK
GermanyFrance Australia
Canada
Italy
Spain
Korea
Saudi ArabiaA rg entina
Mexico World
Brazil
RussiaSouth Af r ica
Chin aIndia
Population Effect
Competitive Effect
A
B
Source: CIBC World Markets Inc., IEA
The graph plots the per capita power versus the per capita income for all countries with more than 20 million inhabitants, more than 90% of the world's population. The image shows the broad relation between wealth and energy consumption.
Sometime around 1999, it appeared as if the year over year change in oil prices turned consistently positive, probably due to the growing leverage from emerging economy growth as these nations became larger and larger.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
36
Conclusion There is no shortcut to confronting the problem associated with excessive western government and consumer debt levels. The only real solution is a dramatic improvement in productivity growth. In the interim, a low and stable level of U.S. bond yields is critically important. This may give the U.S. time to work through its housing crisis with the goal of protecting consumer confidence, but the Euro zone continues to struggle with the dangerous combination of enormous debt and very weak economies.
Our focus is on ensuring that U.S. bond yields remain in a safe range so that an ROE recovery can lift U.S. equity prices. The TSX index by comparison is dominated by the energy and materials sector, whose profitability is being driven by growth from emerging countries, yet our financial sector may be the strongest in the world fundamentally. As long as the U.S. economy is stable, the TSX can benefit from relatively high commodity prices with little or no inflation and interest rate risk. Investors must constantly grapple with the following question: Is the equity cycle still intact? If it is, then Canada could probably be said to have the best of all characteristics that are essential to successful investing.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
37
Sector Outlook
Banks & Lifecos
Overweight & Market Weight
Robert Sedran (416) 594-7874 Mike Rizvanovic (416) 594-7283
Sector Outlook As we slowly exit a particularly nasty downturn that featured capital market and macroeconomic turmoil, we believe the central question that must be asked of any financial service company globally is whether the nature of the downturn was cyclical (i.e. earnings are depressed temporarily) or structural (i.e. there is more lasting pressure on profitability). From a global perspective, this question might be difficult to answer across all banking regimes; we think in Canada the answer is reasonably clear.
However, it is here that we note a significant divergence between the Canadian banks and life insurance companies. For the Canadian banks, we are convinced that the vast majority of the impact is cyclical. Pretax pre-provision earnings are higher, core products in the lending and capital markets businesses carry better profitability with less risk and balance sheets are materially stronger. In short, we think they are exiting the downturn in a stronger position than the one in which they entered it – not just when compared against damaged international peers, but against themselves as well.
By contrast, the Canadian lifecos do show signs of structural damage from the downturn, with products that are both higher-risk and less profitable than they appeared to be before the downturn. We see two important implications flowing from this view.
First, our investment thesis for the banks assumes improving profitability and accelerating earnings growth as loan losses continue to decline and the net interest margin benefits from a gradual increase in short-term interest rates. We remain constructive on the capital markets businesses – though we do expect them to slow from an exceptionally strong F2009 – and look for them to remain above historical levels as the banks defend market share gained through the downturn.
Second, on valuation, we believe that bank shares should migrate towards their pre-crisis average of 12x forward earnings, comfortably above the current average F2011 multiple of closer to 10x. Moreover, it is our view that the discount to the Canadian lifecos at which the shares previously traded is no longer appropriate given the lasting negative impact on profitability mentioned above for that sector.
The combination of these two factors leads to a positive 12- to 18-month investment stance on the banks at this time, although we note that after the very strong performance of the shares over the last year, the upside is less compelling than it was. With better earnings visibility and less volatility, we favour the banks over the lifecos at this time.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
38
Regulatory Response To The Crisis Is Still Developing In response to the crisis, both regulators and politicians are actively considering reforms to help reduce the likelihood and/or severity of the next crisis. In our view, after an early response to the crisis that saw the banks aggressively raise capital, balance sheets are very well positioned to meet these challenges. Moreover, we believe all stakeholders will need to balance the goal of improving the safety of the financial system with the desire to not impede what seems likely to be an already sluggish recovery.
That said, while we are confident that the banks can manage tighter capital requirements, we are not dismissive of this issue as an ongoing challenge, especially given the uncertainty created by the upcoming implementation of international accounting standards (IFRS). The potential for unexpected or unintended consequences is elevated. Uncertainty is higher for the life insurance industry, where there has been less visibility on the potential impact of greater requirements.
3-5 Year Outlook Once the recovery from cyclically depressed earnings is largely complete (we assume F2011 for the banks), we look for a return to more normal single-digit earnings growth rates for the sector. Presumably the regulatory environment will be more stable by this time, which implies that the excess capital being generated in the mature Canadian market will be in part returned to shareholders through higher dividends and share repurchase programs and in part deployed into international expansion strategies. The relative success of these expansion initiatives will be an ever larger influence on relative returns. Here again, we believe the Canadian banks remain relatively well positioned compared to their international peer group given the exceptionally strong domestic franchise.
Top Picks TD Bank (TD–SO) is currently our top pick given the company’s above-average leverage to falling loan losses, continued strong performance of the core retail franchises, our optimism regarding the firm’s U.S. personal and commercial banking expansion strategy and what we believe to be a compelling relative valuation.
In our view, the most significant long-term strategic question facing the banks is the deployment of excess capital being generated domestically. In our opinion, TD Bank – which we believe has achieved critical mass in the United States – has one of the best answers to that question. This bank is a leader in the Canadian marketplace and we expect it to perform well in the United States. With solid positioning in both the near term and longer term, we rate the shares Sector Outperformer with an $85 price target.
We also have a favourable view on Bank of Montreal (BMO–SO). This bank retains above-average exposure to falling loan loss provisions, which when combined with better performance in the domestic retail bank, underpins our expectation of the highest earnings growth rate of the banks over the next two years. We currently rate the shares Sector Outperformer with a $72 price target.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
39
Asset Managers & P&C Insurers Market Weight
Paul Holden, (416) 594-8417 Kevin Cheng, (416) 956-6676
Sector Outlook Broadly speaking we favour the property and casualty insurance companies over asset managers in a slow-growth, choppy equity market environment. We would expect the positive underwriting trends we are seeing in the Canadian P&C insurance space to continue. Namely: 1) personal insurance lines are in a hard market as the low interest rate environment dictates that insurers must generate a greater return from underwriting insurance, rather than purely relying on their investment float; 2) regulatory capital levels are strong and getting stronger, a gradual rise in interest rates does not pose the same risk to the market value of float, which is predominately made up of fixed income instruments, as rapid interest rate increases would; and 3) economic growth, albeit lukewarm, is constructive for the volume of insurance underwritten. ROE for the P&C insurers likely bottomed in the first half of 2009 and the cyclical recovery for the industry should continue through at least 2011.
The outlook is somewhat more challenging for the asset managers, whose profits are heavily skewed towards equity-related mandates. A more ideal scenario for the asset management industry would be robust economic growth, poor returns on bond funds fueled by a rapid increase in rates (encouraging investors to buy/switch into equity funds), and a relatively consistent rise in equity markets. Volatile equity markets have already taken their toll on mutual fund flows, with the industry experiencing net redemptions in May of this year compared to average net sales of $1.6 billion for the previous four months of May. Industry AUM is up a measly 0.6% YTD. Retail investors are clearly skittish and will likely remain gun shy if equity markets remain choppy.
Finally, you are paying much more for expected earnings from an asset manager versus an insurance company. The average P/E on 2010 and 2011 expected EPS for the asset managers are 13.9x and 11.5x versus 11.9x and 10.1x for insurance companies.
Top Picks Our top picks in the vertical are Genworth Canada and DundeeWealth.
Valuations for Genworth Canada (MIC–SO) are extremely compelling at 1.0x BV and approximately 8x 2010E and 2011E EPS given the prospect for rising EPS. Claims losses have been trending down since peaking in Q2/09. We expect that trend to continue through our 2010-2011 forecast horizon with improving employment and firm home prices. In our opinion, valuations have recently been pushed down due to concerns over home prices and housing affordability in the context of higher interest rates. CIBC’s outlook for gradually rising rates and manageable personal debt corresponds to an improving earnings environment for Genworth Canada. In addition, the company expects to return a portion of its excess capital to shareholders in 2010, which could total nearly $3 per share.
DundeeWealth (DW–SO) is easily outpacing the industry in terms of mutual fund sale and AUM growth. Through the first five months of 2010, the company has netted $2.0 billion in long-term fund sales, almost one-sixth of the industry
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
40
total. 2010YTD AUM growth is 9.0%, well ahead of the industry at 0.6%. We believe that DundeeWealth will continue to grow faster than the industry during our forecast horizon due to strong fund returns and an overall portfolio tilt in favour of resources. In addition, its hedge fund mandates provide more of an opportunity to generate returns in a volatile market environment, and thus potentially attract more inflows. The company’s balance sheet looks solid with a net cash position of nearly $170 million. Given the superior growth outlook, we think the shares are modestly priced at 5.9x EV/2011E EBITDA versus Canadian comps at 5.8x and US comps at 7.0x.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
41
Exhibit 47. Summary Of Our Ratings & Price Targets
CANADIAN BANKS P/E Multiples P/B Multiples Ticker Rating Price Target Current (1) Historical Avg Target Current (2) Historic Avg Target BMO SO $72.00 10.4x 11.8x 12.2x 1.9x 2.0x 2.1x BNS SP $56.00 10.7x 11.8x 12.5x 2.4x 2.3x 2.5x CM NR $82.00 9.8x 11.1x 11.2x 2.4x 2.3x 2.5x NA SP $67.00 8.6x 10.3x 10.3x 1.7x 1.8x 1.8x RY SP $65.00 10.3x 12.3x 12.7x 2.3x 2.5x 2.5x TD SO $85.00 9.9x 11.6x 12.2x 1.7x 2.1x 2.0x Big Six Average: 10.0x 11.5x 11.9x 2.1x 2.2x 2.2x CWB SU $26.00 11.3x 12.8x 13.0x 1.8x 1.9x 1.9x LB SP $47.00 8.7x 10.9x 10.0x 1.1x 1.0x 1.0x Avg for all Bank: 10.0x 11.6x 11.8x 1.9x 2.0x 2.0x CANADIAN LIFECOS P/E Multiples P/B Multiples Ticker Rating Price Target Current (1) Historical Avg Target Current (2) Historic Avg Target GWO SU $28.00 10.5x 12.8x 12.0x 2.1x 2.8x 2.1x MFC SO $22.00 8.4x 12.7x 11.0x 1.1x 2.1x 1.4x SLF SP $33.00 9.7x 11.8x 10.5x 1.1x 1.5x 1.2x Big Three Average: 9.5x 12.4x 11.2x 1.4x 2.1x 1.6x IAG SO $40.00 10.4x 11.5x 11.5x 1.4x 1.7x 1.6x Avg for all Lifecos: 9.7x 12.2x 11.3x 1.4x 2.0x 1.6x ASSET MANAGERS P/E Multiples P/B Multiples Ticker Rating Price Target Current (1) Historic Avg Target Current (2) Historic Avg Target (3) AGF.B SO $21.25 7.9x 14.4x 11.7x 1.1x 1.9x 1.6x CIX SU $20.00 14.4x 14.1x 15.5x 3.3x 6.1x 3.4x DW SO $20.00 17.0x 22.8x 23.0x 1.9x 2.0x 2.1x GS SO $25.25 9.5x 12.4x 15.7x 6.0x 9.7x 11.9x IGM SP $44.75 12.4x 13.4x 14.3x 2.4x 3.1x 2.6x SII SP $5.25 8.3x 12.0x 12.5x 7.2x 10.4x 9.2x Average: 11.6x 14.9x 15.4x 3.7x 5.5x 5.2x P&C INSURERS P/E Multiples P/B Multiples Ticker Rating Price Target Current (1) Historic Avg Target Current (2) Historic Avg Target (3) IFC SP $53.50 10.3x 10.8x 12.4x 1.8x 1.8x 2.0x MIC SO $33.00 8.0x 9.7x 11.2x 1.0x 1.2x 1.4x Average: 9.2x 10.3x 11.8x 1.4x 1.5x 1.7x OTHER P/E Multiples P/B Multiples Ticker Rating Price Target Current (1) Historic Avg Target Current (2) Historic Avg Target (3) DHF.UN SP $17.75 10.3x 8.2x 11.1x 1.5x 1.8x 1.6x OCX SO $38.75 nm nm nm 2.1x 3.1x nm Average: 10.3x 8.2x 11.1x 1.8x 2.4x 1.6x (1) Based on our current EPS estimates for F2011. (2) Based on the current book value per share. Source: Thomson Analytics, company reports, and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
42
Mining— Precious Metals Overweight
Barry Cooper, (416) 956-6787 Cosmos Chiu, (416) 594-7106 Brian Quast, (416) 956-3725 Khaled Sultan, (416) 594-7297 Kevin Chiew, (416) 594-7457 Robert Hales, (416) 594-7261
Sector Outlook Gold is asserting itself as an investment providing safety and performance. The economic factors that have driven gold to current levels continue to plague the world, with these aspects underpinned by strong fundamental criteria. Primary production remains stagnant. Secondary supply such as Central Bank selling is dwindling. While jewelry demand has softened due to higher prices, it has been more than replaced by increased investor purchases of gold, as evidenced by the strength of the bullion-backed ETFs that now house 10 months of mine supply. Five years ago, the holdings in ETFs were less than a week’s supply.
We believe that investors will continue to seek diversification to the multitude of uncertain factors described in the Economics section of this report, including debt build up, currency debasing, market volatility, and general mayhem in world geopolitics. With limited supply, we think that demand will continue to drive gold prices higher.
Whereas most of the time gold prices behave as negatively correlated movements against the US dollar, 2010 has seen both the trade-weighted dollar and US dollar gold prices increase by about 13%. The reaction is uncommon, but not without precedent, occurring about 18% of the time. In most cases, the correlation flips when some other major currency wavers in strength. Turmoil in Europe has provided the basis for not only currency devaluation, but the movement of money into gold bullion as a means to preserve capital. We believe there will be a rotation of compounding problems that ripple through world markets, causing an extended period of varying uncertainty that should maintain the interest in gold.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
43
Gold equities appear inexpensive relative to the commodity itself. The 23-year range of units of the XAU purchased for an ounce of gold has been between 3 and 6. It currently sits at 7 or 65% above the long-term average and 45% above the average trading levels of the past decade. We think that either gold shares are reflecting an impending lower gold price or they are mismatched with the commodity and the improved earnings power of the group. Some of the major gold producers are now trading below the average P/E multiple for the S&P 500 for the first time in history. We think that newcomers to the group may look upon gold stocks with traditional valuation criteria and find the group attractive under this measure as opposed to the more common metric of net asset value where gold shares typically appear more expensive than other sectors.
Top Picks IAMGOLD (IAG–SO) is likely to benefit from a number of catalysts over the next six months including the startup at Essakane, appointment of a new CEO, and new discoveries at Rosebel. Amongst names in our universe, Eldorado Gold (EGO–SO) has the best growth profile for next year plus among the best reductions in operating costs. Red Back (RBI–SO) is one of the few companies that are experiencing growth, both in terms of production as well as reserves. Semafo (SMF–SO) should benefit from continued growth at Mana, while Franco-Nevada (FNV–SO) offers a superior risk-return profile. Pan American Silver (PAAS–SO) benefits from an excellent operating history, and growth from the recently acquired Navidad project.
Amongst the non-producers, we favour:
Detour Gold (DGC–SO), which we believe represents good value and potential for expansion through further drilling results and the transition to production albeit two years off. Kirkland Lake (KGI–SO) has high grades with the potential of scaling up production that is building as of now. Osisko (OSK–SO) is transitioning into an intermediate producer within 12 months and is a likely takeout candidate.
In the seniors’ space, our ranking is as follows:
Goldcorp (GG–SO) is one of the few seniors that is forecast to experience growth in production of 10%-15% per year over the next five years. Barrick (ABX–SP) has delivered a strong operational performance that is likely to draw attention to the name. Newmont (NEM–SP) offers investors the prospect of gold leverage coupled with steady state production. Finally, we think Kinross’ (KGC–SU) growth has been impaired but prospects should improve in 2012.
A profile of our coverage universe and current ratings is shown below.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
45
Mining— Metals & Minerals Market Weight
Alec Kodatsky, (416) 594-7284 Ian Parkinson, (416) 956-6169 Terry K.H. Tsui, CFA, (416) 956-3287 Matthew Gibson, (416) 956-6729
Constructive Pricing Outlook Despite Subdued Growth Environment All figures in U.S. dollars, unless otherwise stated.
Sector Outlook – Near Term We believe that in the near term, base metal and bulk commodities can sustain price levels well above historical averages despite a subdued outlook for global economic growth, with positive implications for related equities. The dramatic rise in commodity prices between 2004 and 2008 was fuelled by an extended period of strong geosynchronous economic growth, resulting in an acute scarcity of supply across all commodities. In the absence of a similar economic environment, we expect a generally more balanced supply-demand picture, but estimate that critical supply shortages persist in copper, metallurgical coal and iron ore, even under benign growth assumptions.
Key to our demand expectations is a sustained GDP growth rate in China of 8%, well below the double-digit growth rates observed at the beginning of 2010, and very modest economic growth in the Western World. China currently consumes approximately 30%-35% of global metal supply and accounts for a remarkable 75% of metal demand growth annually. When viewed in this light, we believe it becomes clear that subdued growth expectations for the Western World should be less of a concern for the commodities complex than current sentiment might suggest. We believe our view aligns closely with Avery Shenfield’s expectations for a relatively weak economic recovery in developed nations, with growth being more heavily skewed towards emerging markets.
For this reason, we strongly prefer investment exposure to copper, metallurgical coal and iron ore over an 18-month horizon, as we believe they are the most likely commodities to sustain elevated price levels and possibly rise further. Additionally, the equities with underlying exposure to these commodities should demonstrate exceptional levels of profitability relative to their peers.
We remain less inclined to invest in aluminum, zinc and nickel in the near-term for two key reasons: 1) we believe current supply is outpacing demand for these commodities; and 2) substantial inventories of these metals accumulated during the recent economic downturn. That said, we see limited downside to the prices for these metals from current levels. We have already begun to see the emergence of substantial output cutbacks in zinc, aluminum and nickel, in the order of 5% to 10% of global supply. This rational response in a timely fashion lessens the risk, in our view, of further accumulation of surplus metal inventories (which could further depress market prices for an extended period). Additionally, much of the higher-cost “swing” production capacity of these commodities is in China. Declining domestic Chinese production typically necessitates the increase of metal imports to offset the drop in supply, which typically has positive pricing implications.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
46
Sector Outlook – Long Term Over a 3- to 5-year horizon, we expect the supply-demand picture for the sector to undergo substantial changes. Our forecast high price environment for copper and bulk materials should stimulate the addition of significant new supply, albeit with a higher cost structure due to rising energy costs and the general deterioration in the relative quality of new projects. This should prove supportive for longer-term pricing, to the benefit of existing lower-cost producers. In the case of metallurgical coal and iron ore, we believe there is sufficient supply of new projects that a constrained growth environment should balance the market in 3 to 4 years, leading to a normalization of prices. We forecast that the copper market will continue to remain very tight, and in deficit for the foreseeable future. In our estimates, this deficit becomes significant in 2012, and at this point there is insufficient new supply in the pipeline to balance the market. This should prove supportive for copper prices over a long-term horizon. The availability of project financing and tax stability remain key risks to this view. Should financing availability decline, and/or potential changes to tax regimes discourage new project development, these markets could become tighter than we currently expect.
Given our expectations for weaker relative pricing, we anticipate less new supply of zinc, uranium and aluminum and, to a lesser extent, nickel in the coming years. Consequently, relative underinvestment should improve pricing prospects over a longer-term horizon. For example, few companies are devoting any capital to investments in zinc. The high capital intensity of new aluminum supply may deter investment in new projects and possible technical challenges associated with new nickel laterite projects may crimp supply expectations and deter further investment in this critical new source of supply for that metal. The current uranium price is not enticing large-scale investment, which we think will compound to project supply shortages out 3-5 years. Therefore, even during a period of subdued growth, we can envision several scenarios generating positive pricing implications. With downside price risk capped by the emergence of higher-cost new capacity, the risk-reward profile appears skewed to the upside.
On a 3- to 5-year view, we would maintain an overweight exposure to copper on the basis of its very positive long-term supply-demand fundamentals. Although less certain, we would be inclined to transition away from bulk commodity exposure over the longer term in favour of zinc, aluminum, uranium and nickel.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
47
Equity Valuation Outlook Current equity valuations are extremely compelling, in our view, with the space on average offering in excess of 40% upside potential under our conservative commodity price assumptions. We estimate the market valuations for our covered mining equities imply long-term commodity prices well below the cost of production of many current producers. This, in our view, is unsustainable and is reflective of the uncertainty surrounding Euro zone growth and the potential impact of a cooling Chinese economy. While these events could continue to weigh on investor sentiment for the next few months, we believe that equity valuations for the metals and mining space will ultimately be supported by what continue to be highly profitable commodity prices. Strong cash flow generation among our companies should in turn promote significant returns of capital to shareholders, instigate a revival in M&A activity and support the financing of growth opportunities—all of which have positive implications for equity valuations.
Top Picks Our favoured stock recommendations focus on exposure to our preferred commodities (copper, metallurgical coal and iron ore) and are well-capitalized companies with good growth pipelines and a solid, low-cost operational base. Our preferred names are Teck (TCK.B–SO), Equinox (EQN–SO), Quadra FNX (QUX–SO), Consolidated Thompson (CLM–SO) and, as higher political risk plays, First Quantum (FM–SO) and Taseko (TKO–SO).
Exhibit 51. Summary Of Our Ratings Market Cap. Company Ticker Exchange Currency Share Price (US$mlns.) Rating Copper Capstone Mining CS TSX US$ 2.29 453 SP Equinox EQN TSX US$ 3.91 2,766 SO First Quantum FM TSX US$ 55.79 4,496 SO Ivanhoe Mines IVN TSX US$ 14.5 6,402 SP Mercator Minerals ML TSX US$ 1.77 345 SP Quadra FNX Mining QUX TSX US$ 12.25 2,310 SO Taseko TKO TSX C$ 5.16 961 SO
Uranium Bannerman BAN TSX A$ 0.28 56 SO Cameco CCO TSX C$ 23.78 9,345 SP Denison DML TSX US$ 1.35 459 SP Paladin PDN TSX US$ 3.45 2,474 SO Uranium Energy UEC AMEX US$ 2.62 159 SO Uranium One UUU TSX US$ 2.25 1,322 Restricted
Diversified and Other HudBay HBM TSX C$ 11.4 1,735 SO Inmet Mining IMN TSX C$ 44.63 2,504 SP Lundin LUN TSX US$ 3.67 2,128 SO Sherritt S TSX C$ 6.5 1,912 SP Teck TCK.B TSX C$ 34.93 20,607 SO
Molybdenum General Moly GMO AMEX US$ 3.57 259 SO Thompson Creek TCM TSX US$ 9.42 1,317 SP
Iron Ore Baffinland BIM TSX C$ 0.42 144 SO-S Consolidated Thompson CLM TSX C$ 8.11 1,870 SO New Millennium NML TSX C$ 1.02 136 SO-S Labrador Iron Ore LIF.UN TSX C$ 48.2 1,542 SP Source: CIBC World Markets Inc., Bloomberg
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
48
Oil & Gas Market Weight
Andrew Potter, (403) 221-5700 Jeff Fetterly, (403) 216-3400 Jeremy Kaliel, (403) 260-8657 Adam Gill, (403) 216-3405 Diana Chaw, (403) 216-8518 Nick Lupick, (403) 221-5049 Jon Morrison (403) 216-3402 Jeff Shen, (403) 221-5047 Kyle Balaux (403) 216-3401
Sector Outlook Commodity Outlook – Taking An Oil Bias In Short Term WTI prices have remained volatile in recent months, with spot prices trading above US$85.00/Bbl at the beginning of April down to the US$70/Bbl level recently on concerns of global oil demand stalling. We forecast US$80/Bbl in 2010 and US$85/Bbl in 2011. The short- to medium-term price of oil has less to do with specific inventory levels and more to do with sentiment regarding the global economy. Sentiment towards the global economies took a severe turn for the negative surrounding the Greek bailout. However, with global GDP growth expected to remain around the 4% level for the foreseeable future, we see global oil demand increasing moderately, leading to gradual erosion in spare capacity. It will be difficult for oil prices to move much beyond US$90/Bbl without a significant erosion in spare capacity – which is still likely several years away.
The short-term outlook for natural gas prices remains relatively bleak as inventories are plentiful and the pace of drilling is once again accelerating driven by aggressive development of gas shales. Even with low prices, producers continue to drill aggressively, particularly in the US, in a bid to hold lands. With this back-drop, it is difficult to see a scenario where inventories are eroded sufficiently to bring the supply-demand equation back into balance. We forecast natural gas prices of US$4.75/Mcf in 2010 and gradually moving back up to a long-term sustainable price of US$6/Mcf. Over the long term (2012+), we believe the industry requires US$6.00/Mcf to generate sufficient cash flow to fund drilling efforts at the necessary pace.
Key Themes Given our view of oil prices trading in a US$70-$90/Bbl range through 2011, we expect less commodity momentum than 2009, when oil rallied 78% and the sector as a whole increased 43%. With the oil price forecast to be somewhat range-bound in 2010 and 2011, we believe stock returns will be driven more by company-specific factors such as growth and valuation re-rating/de-rating. Overall, we project 20% returns for the group as a whole based on our US$85/Bbl and US$6/Mcf long-term commodity price forecasts.
Overall sector valuations are quite attractive following the recent selloff with the average large cap trading at 80% of ‘risked’ NAV and 6.0x 2011 EV/DACF—slightly below historical valuation ranges. We believe the sector is discounting an approximately US$70/Bbl oil price over the long term, which is quite a discount from our US$85/Bbl forecast.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
We expect corporate activity to remain high over H2/2010 and 2011 in terms of both M&A and potential corporate splits. We believe there is a large disconnect between oil sands valuations in the asset market (both producing assets and non-producing) and what is implied in corporate valuations. This disconnect may be a precursor to M&A. We also believe that further corporate splits are possible. Husky (HSE–SO) is the most likely given its public musings of spinning off its international assets. We highlight Talisman (TLM–SO) as having the most to gain if it spun off is North American assets in the next 12-18 months.
A dominant theme in the Canadian space will continue to be the progression towards long-life resources. As long-life resources comprise a greater proportion of production, we expect valuations to continue to expand for the sector as a whole.
Oil sands have received a bad rap over the past few years – both environmentally and in terms of economics. While the environmental backlash is still in full swing, the underlying economics have improved remarkably thanks to slightly lower costs, lower natural gas prices and tightening light-heavy differentials. We believe non-upgraded SAGD projects offer some of the best risk-adjusted rates of return in the world while still holding significant optionality on technology. We continue to believe technology could unlock further value in the oil sands, similar to the impact it had on shale gas.
Top Picks We highlight Suncor (SU–SO), Talisman (TLM–SO) and Nexen (NXY–SO) as our top investment ideas, with return potential at or around 30%.
Suncor – Sector Outperformer ($44 target, 29% implied return) We believe Suncor's valuation is poised to re-rate upwards as the company completes its asset sales and once again starts to deliver reliable oil sands operations. The valuation re-rating combined with above-average growth should lead to outperformance versus its domestic and global peers. We believe Suncor is capable of delivering 8% oil-weighted production growth through 2015 at least by spending only 65% of cash flow - a rare combination of growth and free cash flow. Following the $3-4 billion of asset sales, we expect Suncor to have debt down to the $9.5-10.5 billion range by the end of 2010 at which point the company will be well situated to begin to utilize the substantial free cash in 2011/2012 to increase debt or buyback shares.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
50
Nexen – Sector Outperformer ($30 target, 30% implied return) Nexen has been a chronic underperformer, but following a solid string of exploration success in 2008/09, we believe it has better-than-average growth potential/visibility and catalyst potential. Weak results from Long Lake in 2008 and 2009 have overshadowed Nexen's strong performance elsewhere. Major discoveries in the Eastern Gulf of Mexico, North Sea and West Africa, along with commercialization of Horn River shale gas, implies that Nexen can generate ~8% average growth through 2015. Long Lake is showing encouraging signs, but is still a long way from peak production. We believe it will achieve cash flow breakeven within the next few months and be generating ~$300 million of annualized cash flow by late 2010 - a level that will likely lead to some market recognition for this asset. We believe Horn River is a hidden gem in Nexen's portfolio. In a US$5/Mcf+ gas price scenario, we believe Nexen could ramp up production from this asset to 90 MMcf/d by year-end 2011 and 140 MMcf/d by year-end 2012, making it one of Nexen's largest single producing assets. Talisman – Sector Outperformer ($23 target, 28% implied return) After many years of below-average performance and valuation, we believe Talisman has the asset mix to finally see the valuation expand. Talisman has transformed its uncompetitive North American gas business to top tier. We believe the company is now capable of 10%-15% gas production growth through 2015, led by the Marcellus play. By year-end 2010, we expect unconventional to represent approximately 50% of North American production. Talisman's international business has also transformed with vastly improved growth visibility and greater exposure to high impact exploration. In H2/10 and early 2011, we expect a steady stream of exploration results, with our focus being primarily Colombia and Indonesia. Should Talisman's valuation not re-rate as we expect, the company would be prime for a break-up in the next 12-18 months. In a break-up scenario, we estimate our $23 target would be easily achieved and there could be upside to the $30/share level.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
51
Exhibit 53. Summary Of Our Ratings & Price Targets
2010E
Ticker Analyst Price Rating Price
Target1 Price
Return Mkt Cap ($C Bln) EV/EBITDA Price /
Unrisked NAV Seniors
Integrateds Cenovus Energy CVE Potter $29.70 SO $35.00 18% $22.3 N/A 81% Husky Energy HSE Potter $26.11 SO $32.00 23% $22.2 N/A 66% Imperial Oil Ltd IMO Potter $40.58 SU $44.00 8% $34.4 N/A 82% Suncor Energy SU Potter $31.93 SO $44.00 31% $52.3 N/A 67% Average 20% Canadian Large Caps Canadian Natural Resources CNQ Potter $37.27 SP $41.00 10% $40.6 N/A 78% Canadian Oil Sands Trust COS Potter $28.01 SP $30.00 7% $13.6 N/A 89% Encana2 ECA (US) Potter $33.10 SP $38.00 13% $24.7 N/A 46% Nexen NXY Potter $22.62 SO $30.00 33% $11.9 N/A 55% Talisman Energy TLM Potter $17.80 SO $23.00 29% $18.1 N/A 45% Average 18% Small Cap Oil Sands OPTI Canada OPC Potter $1.89 Spec SO $2.40 27% $0.53 N/A 40% UTS Energy UTS Potter $2.31 SO $2.75 19% $1.10 N/A 60% Average 23%
Intermediate & Junior Producers Anderson Energy AXL Gill $1.26 SO $1.65 31% $0.22 N/A 127% Angle Energy NGL Gill $8.25 R R R $0.50 R R Provident Energy PVE.UN Gill $7.62 SP 8.25 8% $2.01 N/A 89% 20%
Energy Equipment & Services Calfrac Well Services CFW Fetterly $20.40 SO $27.50 35% $0.88 8.8x N/A Cathedral Energy Services CET Fetterly $5.89 SO $7.25 23% $0.21 7.8x N/A Ensign Energy Services ESI Fetterly $12.88 SP $16.50 28% $1.97 5.8x N/A Flint Energy Services FES Fetterly $13.01 SO $17.00 31% $0.59 4.6x N/A Mullen Group MTL Fetterly $14.01 SO $19.00 36% $1.13 7.2x N/A Newalta NAL Fetterly $8.81 SO $12.00 36% $0.43 5.5x N/A North American Energy Partners3 NOA Fetterly $10.21 SP $12.50 22% $0.37 4.8x N/A Pason Systems PSI Fetterly $11.36 SP $13.00 14% $0.93 8.5x N/A Phoenix Technology Income Fund PHX.UN Fetterly $8.29 SP $10.50 27% $0.22 9.0x N/A Precision Drilling PD Fetterly $7.63 SO $10.00 31% $2.10 6.1x N/A Savanna Energy Services SVY Fetterly $6.10 SP $7.50 23% $0.48 8.1x N/A Total Energy Services TOT Fetterly $8.00 SP $10.50 31% $0.25 6.1x N/A Trican Well Service TCW Fetterly $13.73 SO $17.50 27% $1.97 9.7x N/A Trinidad Drilling TDG Fetterly $5.24 SP $7.00 34% $0.63 6.2x N/A Average 28% 7.0x
Capital Equipment Finning International FTT Fetterly $17.68 SP $22.00 24% $3.02 8.1x N/A Toromont Industries TIH Fetterly $24.24 SP $32.00 32% $1.86 9.3x N/A Average 28% 8.7x
1) Price targets are 12 to 18 months 2) All figures in $USD unless stated otherwise 3) North American Energy Partners has a March 31st fiscal year-end. As such, comparative figures shown are offset (i.e., 2009 figures are for the 12 months ended March 31, 2010 (FY2010E)). Source: Company reports, Bloomberg and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
52
Consumer Products—Merchandising Market Weight
Perry Caicco, (416) 594-7279 Mark Petrie (416) 956-3278
Sector Outlook We don’t pretend to be economists, but recent results from the more discretionary retail companies (Forzani [FGL–SO], Canadian Tire [CTC.A–SP), Reitmans [RET–TSX]) suggest that Canadian consumers are spending at reasonable rates, almost as if a recession never happened. As always, certain sectors have fared better than others (sporting goods, hardlines, garden strong; apparel and furniture weaker), but it’s basically back to normal for the Canadian consumer.
When we think about the outlook for Canadian retail and consumer stocks, we consider six major issues: the Canadian dollar exchange rate; government intervention; Walmart (WMT–NYSE); the continued growth of the ethnic consumer; new entrants; and, finally, expansionary efforts outside of Canada. All of these will play meaningful roles in how investors should examine the consumer products and merchandising vertical.
Most Canadian retailers have been benefitting from the strong Canadian dollar since lower purchasing costs for goods sourced offshore have not turned up in lower retail prices. This has created a profit windfall in everything from fruits and vegetables to strollers, patio furniture and sports equipment. Prices have stayed high because there are few aggressive price retailers in the Canadian market; square footage growth is too slow to put pressure on sales productivity; and Walmart is uninterested in opening up the same price gaps here as they have in other countries. However, by August or September, the CAD will lap last year’s levels so profit windfalls will disappear. At that point, retailers may have to carefully raise prices and seek other types of cost efficiencies – in other words, sales may be maintained, but gross profits will be tougher to realize.
The economics of the drugstore industry have been severely damaged by government intervention in Ontario, and it is probable that other provincial governments will follow. As the major insurers of Canadians consuming prescription pharmacy products, provincial governments are seeking savings and drugstores are easy targets. These interventions will also impact grocers and mass merchants who sell pharmacy products. Over time, the independent networks will likely shrink, and sales should be driven into more-efficient chain operations, but that may not begin to occur for a couple of years.
In most countries, Walmart is a formidable force, but not in Canada. On the general merchandise side, the retailer has come close to maximizing its business over the past 15 years and there’s not much more to conquer. Hence, while prices are “low”, they are not predatory. On the food side, the company has grown to over $3 billion in sales (in a $78 billion food market), but has struggled to produce decent returns. The traditional Supercenter model has not driven strong results (for a wide variety of reasons), and the latest project is to simply jam fresh food into existing small discount stores. Because returns have been poor, the company prices right with Canada’s traditional discount food operators, but not below.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
53
Canada’s liberal immigration laws have led to huge growth in populations of ethnic new Canadians, most notably from Asia and South Asia. These have become a powerful economic force, but their spending patterns and shopping behaviours are unlike those of traditional Canadians, or even those of traditional European immigrants. They have in many geographies developed their own shopping venues and these venues are steadily siphoning sales from traditional Canadian retailers, who are struggling to respond and serve.
Investors in Canadian companies live in constant fear of multinational retail or consumer companies entering Canada and destroying the existing competitors. Walmart, Costco and Home Depot had that impact in the early 1990s; specialty apparel is continually being invaded; and threats remain on a number of fronts. Recent fears include possible entries from Target (TGT–NYSE), Aldi, Lidl or Dollar General (DG–NYSE). As Canadian retail has become more sophisticated, these threats are somewhat muted. Nevertheless, the generally high pricing (on an international basis) in the Canadian market could attract selected discount entrants.
With a finite market to serve, it is imperative that Canadian companies at least consider other markets. The U.S. has been a cemetery for Canadian consumer companies in the past, but more recently aggressive expansions by Tim Hortons THI–SP), Gildan (GIL–SP), Aeroplan (AER–SO), Couche-tard (ATD.B–SO), Cott (COT–SO) and Weston (WN–SP) have worked out well.
Top Picks Dollarama (DOL–SO) is a fast-growing niche retailer, dominant in the “dollar” category in Canada. It has strong same-store sales, with good regular traffic growth, and is adding stores in key markets at low rents. Its operating metrics are better than comparable U.S. dollar stores. The company is about to install scanning, which should improve in-stock levels and sales, and reduce shrink and labour costs.
Empire Company (EMP–SO) has over 90% of its asset value domiciled in Sobeys (SBY–TSX), an undervalued supermarket chain with strong same-store sales momentum. Banners are clearly positioned and the company has a solid national presence. Leading-edge logistics and a re-bannered discount store in Ontario should drive earnings growth to levels superior to its comparables.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
54
Exhibit 54. Summary Of Our Ratings
14-Jun LTM Price-to-
earnings ratio Current EV/EBITDA
Company Ticker Currency Rating Share price
Dividend yield
Market cap.
EBITDA Margin
Last year
This year
Next year
Last year
This year
Next year
Consumer Products Groupe Aeroplan Inc. AER CAD Sector Outperformer $ 9.20 5.4% 1,835 18% na na na 9.9x 9.4x 8.0x Alimentation Couche-Tard Inc. ATD/B CAD Sector Outperformer $ 19.04 0.8% 3,617 4% 14.2x 12.2x 10.4x 7.2x 6.7x 6.1x Cott Corporation COT USD Sector Outperformer $ 7.83 0.0% 627 11% 9.8x 9.8x 8.3x 5.3x 4.9x 4.5x Gildan Activewear Inc. GIL USD Sector Performer $ 31.30 0.0% 3,786 20% 37.5x 19.3x 15.5x 22.7x 13.3x 11.1x Saputo Inc. SAP CAD Sector Performer $ 29.64 1.9% 6,148 9% 16.0x 14.0x 12.9x 9.4x 8.6x 8.1x Consumer Products Average 1.7% 15.1% 19.4x 13.8x 11.8x 10.9x 8.6x 7.5x Merchandising Canadian Tire Corporation, Ltd. CTC/A CAD Sector Performer $ 55.62 1.9% 4,539 10% 13.4x 11.8x 10.5x 7.9x 7.5x 7.0x Dollarama Inc. DOL CAD Sector Outperformer $ 25.50 0.0% 1,860 16% 21.0x 17.7x 15.7x 11.7x 10.6x 9.4x Empire Company Ltd. EMP/a CAD Sector Outperformer $ 51.91 1.4% 3,554 5% 12.8x 12.1x 10.6x 6.1x 5.8x 5.3x Forzani Group Limited FGL CAD Sector Outperformer $ 17.19 1.7% 519 7% 16.8x 13.1x 11.0x 6.1x 5.3x 4.9x George Weston Limited WN CAD Sector Performer $ 73.10 2.0% 9,435 6% 21.2x 16.5x 15.6x 7.0x 6.4x 6.1x Loblaw Companies Ltd. L CAD Sector Performer $ 40.00 2.1% 11,048 6% 16.9x 15.5x 14.6x 7.9x 7.2x 6.8x Metro Inc. MRU/a CAD Sector Outperformer $ 42.60 1.6% 4,624 7% 13.4x 12.3x 11.3x 7.4x 7.1x 6.8x North West Company Fund NWF.UN CAD Sector Outperformer $ 19.55 7.0% 948 9% 11.6x 11.3x 13.2x 8.7x 8.3x 7.7x Jean Coutu Group Inc. PJC/a CAD Sector Outperformer $ 8.99 2.4% 2,124 7% 11.6x 11.6x 10.4x 7.6x 6.7x 6.2x RONA Inc. RON CAD Sector Performer $ 15.68 0.0% 2,032 7% 13.3x 11.4x 10.6x 6.9x 6.0x 5.6x Shoppers Drug Mart Corporation SC CAD Sector Performer $ 34.45 2.6% 7,491 11% 12.8x 12.2x 13.1x 7.9x 7.5x 7.8x Tim Hortons, Inc. THI CAD Sector Performer $ 34.40 1.2% 6,177 26% 19.4x 16.9x 15.3x 10.6x 9.6x 9.0x Merchandising Average 2.0% 15.3x 13.5x 12.7x 8.0x 7.3x 6.9x Overall Average 16.4x 13.6x 12.4x 8.8x 7.7x 7.1x Note: For companies not covered by CIBC World Markets, consensus numbers were used. Source: Company reports and Bloomberg
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
Sector Outlook Performance Through Crisis Has Been Very Stong The credit crisis was the first baptism by fire for Canadian REITs and REITs globally. Until 2008, there had been no major economic or real estate downturns to challenge the industry since REITs emerged in their current form in the 1990s as a product of the real estate and economic recession of the early 1990s.
The winners and losers among REITs in the credit crisis were defined by their financing strategies. In Canada, where financing strategies were generally conservative, REITs experienced modest 3% to 5% average total declines in FFO and AFFO from 2008 to 2010E (not annual), with broad-based growth returning in 2011E. This compares very favourably with most other sectors, where earnings and cash flows have greater exposures to shorter-term economic conditions. The vast majority of these declines in FFO and AFFO related to dilutive financings (both debt and equity) completed during the peak of credit market uncertainty.
REIT operating fundamentals have remained very stable, with limited changes in occupancy and mainly positive lifts on lease renewals, partly because of maturing rental rates that were reflective of market rents 5 or 10 years ago when these leases were signed. Demand for commercial real estate remains relatively stable throughout economic cycles, with low-single-digit growth during times of expansion and flat demand during recessions and early recovery.
Sector Outlook – Near Term
Supply of space continues to define real estate market conditions. Real estate cycles are typically ended by development booms that oversupply markets, driven by top-of-cycle optimism. With a few notable exceptions (Calgary, Dubai, etc), most Canadian and mature global markets have avoided over-building, in part due to the speed and severity of the credit crisis, which stifled market optimism.
Stable fundamentals and renewed financial discipline should support stable and growing financial performance from REITs focused in major markets in mature economies. We see these markets as offering risk and return characteristics that appeal to institutional investors, with stable, low-risk environments in which to own property and collect cash flow. Large Canadian pension funds have recently been investing directly in major mature markets like Manhattan office property. In the short term, the U.S. offers relatively stable fundamentals (occupancies and rental rates are stable) and opportunities in financial restructurings, while Canada offers very stable fundamentals, but limited restructurings.
Emerging markets like China, India, and Brazil, offer much greater return potential, driven by higher economic and population growth, developing mortgage markets, and rising incomes. However, they also present greater risk relating to the potential for overbuilding, uncertain property rights, differing and evolving legal and regulatory environments, cultural barriers and emerging market currency exposure. Dubai has already crashed and China could follow.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
56
Brazil appears to have the most favourable real estate market among emerging economies, with strong economic growth, relatively constrained property development and a developing mortgage market.
Demographically driven demand for high yields in a low-growth, low-interest-rate environment positions Canadian REITs to generate attractive returns, including 6%+ current cash yields. Pension funds, life insurance companies and retiring baby-boomers have investment profiles that include net cash outflows that can be well matched with these cash-flow producing assets.
The institutionalization of real estate globally should continue, including the proliferation of the REIT structure, following generally positive outcomes from REITs facing their first major economic and property market crisis. The REIT structure is well positioned to gain real estate ownership market share (currently <10% in Canada), reflecting the advantages it offers over direct ownership of property, which include professional management, geographic diversification, vastly better liquidity and the ability to manage and adjust exposure on a continuous basis. We expect this proliferation will result in a larger, more liquid REIT sector in Canada and globally that will grow in importance as a capital markets sector.
Sector Outlook – Long Term We expect a low-growth, low-inflation environment with more conservative lending practices to result in limited new property development in mature markets over the next 3 to 5 years. Given this outlook, we expect REITs and real estate to perform well, providing average annual returns near the lower end of the 10% to 15% range, assuming stable valuations. We expect these returns to be comprised of distribution income accounting for 6 to 8 percentage points of annual returns, and 3 to 5 percentage points of growth in FFO and AFFO, driven by the levered effects of 1% to 3% same-property NOI growth and the impact of accretive acquisitions. We expect further upside could result from upward revaluation of real estate and REITs, reflecting current spreads of capitalization rates over 10-year government bond yields that are wider than historical averages.
Top Picks H&R REIT (HR.UN–SO, PT: $20.00) is our current top pick among large capitalization Canadian REITs due to its discounted valuation to all other large cap Canadian REITs measured by both AFFO multiples and relative to NAV, and its defensive strategy of targeting long-term leases (avg. 10 years remaining), long-term mortgages (8 years) and high-credit-quality tenants like Bell Canada (BCE–TSX), Telus (T–SO), TransCanada (TRP–SO), Royal Bank (RY–SP) and Canadian Tire (CTC.A–SP). The REIT recently announced a plan to increase distributions by 46% over the next two years, bringing its AFFO payout ratio to approximately 70% (still one of the very lowest payouts in the sector).
Multi-industry Brookfield Asset Management (BAM–SO, PT: $33.00) is another top pick, with a strategy of targeting the ownership and management of real estate, renewable power and infrastructure assets globally, both on its own behalf and for institutional investors. We believe the company is well positioned to generate strong returns from its high-quality asset portfolio and attract substantial new capital to manage on behalf of institutional partners. The company has developed robust operating platforms, and has a broad and deep senior management team with strong expertise across each of its operating platforms. In addition, the company has a very strong board of directors, and has strong alignment through considerable insider and management ownership. We believe these characteristics are core to the company's future success.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
57
Exhibit 55. Summary of Our Large Cap Ratings
Est. Est. Unit Price 6/15/10 Market Distribution NAV Avg (Discount)/ Unit Cap. Current Current FFO Multiple AFFO Multiple Per NOI Premium to
Unit Cap. Current CFPS Multiple EPS Multiple Per Prem. to Multi-Industry Rating Price ($mlns) Yield 2010E 2011E 2010E 2011E Unit Est. NAV Brookfield Asset Management SO $24.04 13,799 2.2% 9.2x 8.9x 30.1x 28.0x $30.00 (19.9%) Source: CIBC World Markets Inc., Bloomberg
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
Energy C+T CNQ Canadian Natural Resources Ltd 6.87% C+T ECA EnCana Corp 4.52% C+T ENB Enbridge Inc 3.25% COS.UN Canadian Oil Sands Trust 2.23% IMO Imperial Oil Ltd 1.84% C+T NKO Niko Resources Ltd 0.83% C+T BTE.UN Baytex Energy Trust 0.62% T BNP.UN Bonavista Energy Trust 0.54% T IPL.UN Inter Pipeline Fund 0.53% T PIF.UN Pembina Pipeline Income Fund 0.50% T TCW Trican Well Service Ltd 0.34% T FCE.UN Fort Chicago Energy Partners L 0.26% Total Weight: 22.33% Benchmark Weight: 26.15%
Materials ABX Barrick Gold Corp 7.74% POT Potash Corp of Saskatchewan In 5.42% T K Kinross Gold Corp 2.23% SLW Silver Wheaton Corp 1.21% FM First Quantum Minerals Ltd 0.77% TRE Sino-Forest Corp 0.70% T NGD New Gold Inc 0.44% IMN Inmet Mining Corp 0.40% C+T CG Centerra Gold Inc 0.35% S Sherritt International Corp 0.33% T GAM Gammon Gold Inc 0.19% Total Weight: 19.78% Benchmark Weight: 20.43%
Industrials CNR Canadian National Railway Co 5.17% CP Canadian Pacific Railway Ltd 1.77% Total Weight: 6.94% Benchmark Weight: 5.44%
Consumer Discretionary THI Tim Hortons Inc 1.06% C+T GIL Gildan Activewear Inc 0.68% DII.B Dorel Industries Inc 0.17% RET.A Reitmans Canada Ltd 0.16% Total Weight: 2.07% Benchmark Weight: 4.51% C+T SAP Saputo Inc 0.72% Total Weight: 0.72% Benchmark Weight: 2.96%
Health Care Total Weight: 0.00% Benchmark Weight: 0.46%
Financials TD Toronto-Dominion Bank/The 10.78% C+T BNS Bank of Nova Scotia 9.11% C+T BMO Bank of Montreal 6.03% CM Canadian Imperial Bank of Comm 4.91% PWF Power Financial Corp 3.42% IGM IGM Financial Inc 1.79% GWO Great-West Lifeco Inc 1.73% POW Power Corp of Canada/Canada 1.53% IFC Intact Financial Corp 0.91% BPO Brookfield Properties Corp 0.67% T REF.UN Canadian Real Estate Investmen 0.33% C+T CWB Canadian Western Bank 0.26% AGF.B AGF Management Ltd 0.18% Total Weight: 41.63% Benchmark Weight: 31.39%
Info tech GIB.A CGI Group Inc 0.71% MDA MacDonald Dettwiler & Associat 0.31% Total Weight: 1.02% Benchmark Weight: 3.02%
Telecom
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
65
T BCE BCE Inc 4.20% Total Weight: 4.20% Benchmark Weight: 3.97%
Utilities C+T TA TransAlta Corp 0.80% C+T EMA Emera Inc 0.50% Total Weight: 1.31% Benchmark Weight: 1.69%
Source: Company reports and CIBC World Markets Inc.
Energy C+T CNQ Canadian Natural Resources Ltd -2 7.00% C+T ECA EnCana Corp -1 6.85% C+T ENB Enbridge Inc -2 4.10% COS.UN Canadian Oil Sands Trust -3 2.26% IMO Imperial Oil Ltd -4 1.40% C+T NKO Niko Resources Ltd -2 1.05% C+T BTE.UN Baytex Energy Trust -2 0.78% T BNP.UN Bonavista Energy Trust -2 0.69% T IPL.UN Inter Pipeline Fund -2 0.67% T PIF.UN Pembina Pipeline Income Fund -2 0.63% T TCW Trican Well Service Ltd -2 0.53% T FCE.UN Fort Chicago Energy Partners L -2 0.52% Total Weight: 26.48% Benchmark Weight: 26.15%
Materials ABX Barrick Gold Corp -4 5.87% POT Potash Corp of Saskatchewan In -3 5.47% T K Kinross Gold Corp -2 2.82% SLW Silver Wheaton Corp -4 0.92% FM First Quantum Minerals Ltd -5 0.53% TRE Sino-Forest Corp -3 0.71% T NGD New Gold Inc -1 0.67% IMN Inmet Mining Corp -3 0.52% C+T CG Centerra Gold Inc -1 0.54% S Sherritt International Corp -3 0.52% T GAM Gammon Gold Inc -2 0.52% Total Weight: 19.09% Benchmark Weight: 20.43%
Industrials CNR Canadian National Railway Co -4 3.92% CP Canadian Pacific Railway Ltd -4 1.34% Total Weight: 5.26% Benchmark Weight: 5.44%
Consumer Staples C+T SAP Saputo Inc -1 1.09% Total Weight: 1.09% Benchmark Weight: 2.96%
Health Care Total Weight: 0.00% Benchmark Weight: 0.46%
Financials TD Toronto-Dominion Bank/The -4 7.00% C+T BNS Bank of Nova Scotia -2 7.00%
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
66
C+T BMO Bank of Montreal -1 7.00% CM Canadian Imperial Bank of Comm -4 3.72% PWF Power Financial Corp -3 3.45% IGM IGM Financial Inc -3 1.81% GWO Great-West Lifeco Inc -3 1.75% POW Power Corp of Canada/Canada -3 1.55% IFC Intact Financial Corp -4 0.69% BPO Brookfield Properties Corp -4 0.55% T REF.UN Canadian Real Estate Investmen -2 0.52% C+T CWB Canadian Western Bank -2 0.51% AGF.B AGF Management Ltd -5 0.50% Total Weight: 36.05% Benchmark Weight: 31.39%
Info tech GIB.A CGI Group Inc -4 0.54% MDA MacDonald Dettwiler & Associat -3 0.51% Total Weight: 1.05% Benchmark Weight: 3.02%
Telecom T BCE BCE Inc -1 6.37% Total Weight: 6.37% Benchmark Weight: 3.97%
Utilities C+T TA TransAlta Corp -2 1.02% C+T EMA Emera Inc -1 0.76% Total Weight: 1.78% Benchmark Weight: 1.69%
Source: Company reports and CIBC World Markets Inc.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
67
IMPORTANT DISCLOSURES:
Analyst Certification: Each CIBC World Markets research analyst named on the front page of this research report, or at the beginning of any subsection hereof, hereby certifies that (i) the recommendations and opinions expressed herein accurately reflect such research analyst's personal views about the company and securities that are the subject of this report and all other companies and securities mentioned in this report that are covered by such research analyst and (ii) no part of the research analyst's compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by such research analyst in this report.
Potential Conflicts of Interest: Equity research analysts employed by CIBC World Markets are compensated from revenues generated by various CIBC World Markets businesses, including the CIBC World Markets Investment Banking Department. Research analysts do not receive compensation based upon revenues from specific investment banking transactions. CIBC World Markets generally prohibits any research analyst and any member of his or her household from executing trades in the securities of a company that such research analyst covers. Additionally, CIBC World Markets generally prohibits any research analyst from serving as an officer, director or advisory board member of a company that such analyst covers.
In addition to 1% ownership positions in covered companies that are required to be specifically disclosed in this report, CIBC World Markets may have a long position of less than 1% or a short position or deal as principal in the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon.
Recipients of this report are advised that any or all of the foregoing arrangements, as well as more specific disclosures set forth below, may at times give rise to potential conflicts of interest.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
68
Important Disclosure Footnotes for Companies Mentioned in this Report that Are Covered by CIBC World Markets Inc.: Stock Prices as of 06/16/2010: AGF Management Limited (2g, 3a, 3c, 13) (AGF.B-TSX, C$15.18, Sector Outperformer) Agnico-Eagle Mines Limited (2f, 2g) (AEM-NYSE, US$61.03, Sector Performer) Alamos Gold Inc. (AGI-TSX, C$15.82, Sector Outperformer) Alexis Minerals Corporation (2a, 2c, 2e, 2g) (AMC-TSX, C$0.26, Sector Outperformer - Speculative) Alimentation Couche-Tard Inc. (2g) (ATD.B-TSX, C$18.96, Sector Outperformer) Andean Resources Ltd. (2a, 2c, 2e, 2g) (AND-TSX, C$3.03, Sector Outperformer) Anderson Energy Ltd. (2a, 2c, 2e, 2g) (AXL-TSX, C$1.26, Sector Outperformer) Angle Energy Inc. (2a, 2c, 2e, 2g) (NGL-TSX, C$8.24, Restricted) Aurizon Mines Ltd. (2g) (ARZ-TSX, C$5.12, Sector Outperformer) Baffinland Iron Mines Corporation (2a, 2c, 2e, 2g) (BIM-TSX, C$0.42, Sector Outperformer - Speculative) Bank of Montreal (2a, 2c, 2e, 2f, 2g, 3a, 3c, 7) (BMO-TSX, C$63.00, Sector Outperformer) Bank of Nova Scotia (2a, 2c, 2e, 2g, 3a, 3c, 7) (BNS-TSX, C$51.40, Sector Performer) Bannerman Resources Ltd. (2g) (BAN-TSX, C$0.28, Sector Outperformer) Barrick Gold Corporation (2a, 2c, 2d, 2e, 2f, 2g) (ABX-NYSE, US$42.94, Sector Performer) BCE Inc. (2g, 7) (BCE-TSX, C$31.58, Sector Performer) Boardwalk REIT (2g, 7) (BEI.UN-TSX, C$40.27, Sector Performer) Brookfield Asset Management (2a, 2c, 2e, 2g, 3a, 14) (BAM-NYSE, US$24.76, Sector Outperformer) Brookfield Office Properties Canada REIT (2g) (BOX.UN-TSX, C$19.51, Sector Outperformer) Brookfield Properties Corporation (2a, 2c, 2e, 2g, 3a) (BPO-NYSE, US$15.15, Sector Performer) Calfrac Well Services Ltd. (2g) (CFW-TSX, C$21.35, Sector Outperformer) Calloway REIT (2a, 2c, 2e, 2g) (CWT.UN-TSX, C$20.70, Sector Outperformer) Cameco Corporation (2a, 2c, 2e) (CCO-TSX, C$24.42, Sector Performer) Canadian Apartment Properties REIT (2g, 7) (CAR.UN-TSX, C$15.68, Sector Underperformer) Canadian Imperial Bank of Commerce (2a, 2c, 2d, 2e, 2g, 3a, 3c, 6a, 7, 8, 9) (CM-TSX, C$75.00, Not Rated) Canadian National Railway Co. (2g, 7, 9) (CNR-TSX, C$63.20, Sector Performer) Canadian Natural Resources Ltd (2g, 7, 9) (CNQ-TSX, C$38.02, Sector Performer) Canadian Oil Sands Trust (2a, 2e, 2f, 2g, 7) (COS.UN-TSX, C$28.72, Sector Performer) Canadian Pacific Railway Ltd. (2a, 2c, 2e, 2g, 7, 9) (CP-TSX, C$60.70, Sector Performer) Canadian REIT (2a, 2e, 2g, 7) (REF.UN-TSX, C$28.74, Sector Performer) Canadian Tire Corporation, Ltd. (2a, 2e, 2g, 7, 13) (CTC.A-TSX, C$56.97, Sector Performer) Canadian Western Bank (2g) (CWB-TSX, C$24.77, Sector Underperformer) Capstone Mining Corporation (7) (CS-TSX, C$2.34, Sector Performer) Cathedral Energy Services (2g) (CET-TSX, C$5.90, Sector Outperformer) Cenovus Energy Inc. (2a, 2c, 2d, 2e, 2g, 7, 9) (CVE-TSX, C$29.95, Sector Outperformer) Centerra Gold Inc. (2a, 2c, 2e, 2g) (CG-TSX, C$12.44, Sector Performer) CGI Group Inc. (2g, 9, 12) (GIB.A-TSX, C$16.68, Sector Outperformer) CI Financial Corp. (2a, 2c, 2e, 2g) (CIX-TSX, C$18.85, Sector Underperformer) Claude Resources Inc. (2g) (CRJ-TSX, C$1.15, Sector Underperformer) Coeur d'Alene Mines Corp. (2g) (CDE-NYSE, US$15.10, Sector Performer) Cominar Real Estate Investment Trust (2a, 2c, 2e, 2g, 7) (CUF.UN-TSX, C$19.43, Sector Performer) Consolidated Thompson Iron Mines Ltd. (CLM-TSX, C$8.24, Sector Outperformer) Cott Corporation (2a, 2c, 2e, 2g) (COT-NYSE, US$7.91, Sector Outperformer) Davis + Henderson Income Fund (2g, 7) (DHF.UN-TSX, C$16.90, Sector Performer) Denison Mines Corp. (2a, 2c, 2e, 2g) (DML-TSX, C$1.36, Sector Performer) Detour Gold Corporation (DGC-TSX, C$23.67, Sector Outperformer) Dollarama Inc. (2a, 2c, 2e, 2g) (DOL-TSX, C$25.80, Sector Outperformer) DundeeWealth Inc. (2a, 2c, 2e) (DW-TSX, C$15.53, Sector Outperformer)
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
69
Important Disclosure Footnotes for Companies Mentioned in this Report that Are Covered by CIBC World Markets Inc.: (Continued) Stock Prices as of 06/16/2010: Eldorado Gold Corporation (2g) (EGO-NYSE, US$17.19, Sector Outperformer) Emera Inc. (2a, 2c, 2e, 2g, 7) (EMA-TSX, C$25.14, Sector Performer) Empire Company Limited (2g, 7, 13) (EMP.A-TSX, C$52.24, Sector Outperformer) Enbridge Inc. (2a, 2c, 2e, 2g, 7, 9) (ENB-TSX, C$49.95, Sector Outperformer) EnCana Corporation (2a, 2e, 2g, 9) (ECA-NYSE, US$34.51, Sector Performer) Endeavour Silver Corp. (2a, 2c, 2e) (EDR-TSX, C$3.57, Sector Performer) Ensign Energy Services Inc. (2g) (ESI-TSX, C$12.96, Sector Performer) Equinox Minerals Limited (2g) (EQN-TSX, C$4.09, Sector Outperformer) Etruscan Resources Inc. (2g) (EET-TSX, C$0.37, Sector Performer) Finning International Inc. (2g, 3a, 7) (FTT-TSX, C$18.10, Sector Performer) First Capital Realty Inc. (2a, 2c, 2e, 2g) (FCR-TSX, C$14.35, Restricted) First Majestic Silver Corp. (2g) (FR-TSX, C$4.01, Sector Performer) First Quantum Minerals Ltd. (FM-TSX, C$60.09, Sector Outperformer) Flint Energy Services Ltd. (2g) (FES-TSX, C$13.17, Sector Outperformer) Fort Chicago Energy Partners, L.P. (2a, 2c, 2e, 2g) (FCE.UN-TSX, C$10.56, Sector Performer) Fortuna Silver Mines Inc. (2a, 2c, 2e, 2g) (FVI-TSX, C$2.10, Sector Outperformer) Franco-Nevada Corporation (2a, 2e, 2g, 4a, 4b, 7) (FNV-TSX, C$33.15, Sector Outperformer) Gammon Gold Inc. (2g) (GAM-TSX, C$7.82, Sector Performer) General Moly, Inc. (2g) (GMO-AMEX, US$3.73, Sector Outperformer) Genworth MI Canada Inc. (2a, 2c, 2e, 2g, 7) (MIC-TSX, C$23.71, Sector Outperformer) George Weston Limited (2g, 7) (WN-TSX, C$75.87, Sector Performer) Gildan Activewear Inc. (2g) (GIL-NYSE, US$31.55, Sector Performer) Gluskin Sheff + Associates Inc. (2g, 12) (GS-TSX, C$17.35, Sector Outperformer) Gold Wheaton Gold Corp. (2g) (GLW-TSX, C$2.40, Sector Performer) Goldcorp Inc. (2a, 2e, 2f, 2g, 3a, 3c) (GG-NYSE, US$43.27, Sector Outperformer) Golden Star Resources Ltd. (2g) (GSS-AMEX, US$4.10, Sector Performer) Great-West Lifeco Inc. (2a, 2c, 2e, 2g) (GWO-TSX, C$25.23, Sector Underperformer) Groupe Aeroplan Inc. (2a, 2c, 2e, 2g, 7) (AER-TSX, C$9.32, Sector Outperformer) H&R REIT (2a, 2c, 2e, 2g) (HR.UN-TSX, C$17.00, Sector Outperformer) Hecla Mining Company (2g) (HL-NYSE, US$5.45, Sector Underperformer) HudBay Minerals Inc. (7) (HBM-TSX, C$11.70, Sector Outperformer) Husky Energy Inc. (2a, 2c, 2e, 2f, 2g) (HSE-TSX, C$26.51, Sector Outperformer) IAMGOLD Corporation (2g) (IAG-NYSE, US$17.57, Sector Outperformer) IGM Financial Inc. (2a, 2c, 2e, 2g) (IGM-TSX, C$39.25, Sector Performer) Imperial Oil Limited (2g) (IMO-TSX, C$41.53, Sector Underperformer) Industrial Alliance Insurance And Financial Services Inc. (2a, 2c, 2e, 7) (IAG-TSX, C$35.06, Sector Outperformer) Inmet Mining Corporation (2a, 2c, 2e, 2g) (IMN-TSX, C$47.44, Sector Performer) Intact Financial Corp. (2a, 2c, 2e, 2g, 3a, 3c, 7, 14) (IFC-TSX, C$44.19, Sector Performer) Inter Pipeline Fund, L.P. (2a, 2c, 2e, 2g, 7) (IPL.UN-TSX, C$11.90, Sector Outperformer) Ivanhoe Mines Ltd. (2a, 2e, 2g) (IVN-TSX, C$14.97, Sector Performer) Jean Coutu Group (PJC) Inc. (2g, 7, 12) (PJC.A-TSX, C$9.07, Sector Outperformer) Kinross Gold Corporation (2g) (KGC-NYSE, US$17.66, Sector Underperformer) Kirkland Lake Gold Inc. (KGI-TSX, C$8.73, Sector Outperformer) Labrador Iron Ore Royalty Income Fund (7) (LIF.UN-TSX, C$47.40, Sector Performer) Lake Shore Gold Corp. (LSG-TSX, C$3.06, Sector Performer) Laurentian Bank (2g) (LB-TSX, C$44.68, Sector Performer) Loblaw Companies Limited (2g) (L-TSX, C$40.51, Sector Performer)
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
70
Important Disclosure Footnotes for Companies Mentioned in this Report that Are Covered by CIBC World Markets Inc.: (Continued) Stock Prices as of 06/16/2010: Lundin Mining Corporation (2g) (LUN-TSX, C$3.80, Sector Outperformer) MacDonald, Dettwiler and Associates Ltd. (2g) (MDA-TSX, C$43.64, Sector Outperformer) Manulife Financial Corporation (2a, 2c, 2e, 3a, 3c, 7) (MFC-TSX, C$16.76, Sector Outperformer) Mercator Minerals Ltd. (2g) (ML-TSX, C$1.79, Sector Performer) Metro Inc. (2g, 7, 12) (MRU.A-TSX, C$43.17, Sector Outperformer) Minefinders Corporation Ltd. (2g) (MFL-TSX, C$9.46, Sector Outperformer) Mineral Deposits Limited (2g) (MDM-TSX, C$0.73, Sector Outperformer) Mullen Group (2g) (MTL-TSX, C$14.57, Sector Outperformer) National Bank Of Canada (2a, 2e, 2g, 3a, 3c, 7, 8) (NA-TSX, C$58.98, Sector Performer) New Gold Inc. (2g) (NGD-TSX, C$6.58, Sector Performer) New Millennium Capital Corp. (2g) (NML-V, C$1.00, Sector Outperformer - Speculative) Newalta Inc. (2a, 2c, 2e, 2g) (NAL-TSX, C$8.80, Sector Outperformer) Newmont Mining Corporation (2a, 2b, 2c, 2d, 2e, 2g, 3a, 3b) (NEM-NYSE, US$56.33, Sector Performer) Nexen Inc. (2a, 2c, 2d, 2e, 2g, 3a, 3b) (NXY-TSX, C$23.11, Sector Outperformer) North American Energy Partners (2a, 2e, 2g) (NOA-TSX, C$10.51, Sector Performer) North West Company Fund (2g, 7) (NWF.UN-TSX, C$19.58, Sector Outperformer) Northgate Minerals Corporation (2a, 2c, 2e, 2g) (NXG-AMEX, US$2.99, Sector Outperformer) Onex Corporation (2g, 12) (OCX-TSX, C$26.34, Sector Outperformer) OPTI Canada Inc. (2a, 2c, 2e, 2g) (OPC-TSX, C$1.92, Sector Outperformer - Speculative) Orezone Gold Corporation (2a, 2c, 2e, 2g) (ORE-TSX, C$0.83, Sector Performer) Osisko Mining Corporation (2g) (OSK-TSX, C$11.24, Sector Outperformer) Paladin Energy Ltd. (2g) (PDN-TSX, C$3.53, Sector Outperformer) Pan American Silver Corp. (2a, 2e, 2g) (PAAS-NASDAQ, US$25.54, Sector Outperformer) Pason Systems Inc. (2g) (PSI-TSX, C$11.15, Sector Performer) Pembina Pipeline Income Fund (2g, 7) (PIF.UN-TSX, C$17.61, Sector Underperformer) Perseus Mining Limited (2a, 2c, 2e, 2g) (PRU-TSX, C$1.85, Sector Outperformer) Phoenix Technology Income Fund (2a, 2c, 2e, 2g, 7) (PHX.UN-TSX, C$8.33, Sector Performer) Potash Corporation (2a, 2b, 2c, 2d, 2e, 2f, 2g) (POT-TSX, C$104.20, Sector Performer) Precision Drilling Trust (2g) (PD.UN-TSX, C$7.67, Sector Outperformer) Primaris Retail REIT (2a, 2c, 2e, 2g, 7) (PMZ.UN-TSX, C$18.27, Sector Outperformer) Provident Energy Trust (2g) (PVE.UN-TSX, C$7.70, Sector Performer) Quadra FNX Mining Ltd. (2a, 2e, C97) (QUX-TSX, C$12.58, Sector Outperformer) Rainy River Resources Ltd. (RR-TSX, C$6.65, Sector Underperformer) Red Back Mining Inc. (RBI-TSX, C$26.65, Sector Outperformer) RioCan REIT (2a, 2c, 2e, 2g, 7) (REI.UN-TSX, C$19.10, Sector Outperformer) RONA Inc. (2a, 2e, 2g, 7) (RON-TSX, C$15.90, Sector Performer) Royal Bank of Canada (2a, 2c, 2e, 2f, 2g, 3a, 3c, 7) (RY-TSX, C$54.71, Sector Performer) Royal Gold, Inc. (2g) (RGLD-NASDAQ, US$52.55, Sector Performer) Rubicon Minerals Corporation (RMX-TSX, C$3.38, Sector Underperformer) San Gold Corporation (2g) (SGR-V, C$4.40, Sector Performer) Saputo Inc. (2g, 7) (SAP-TSX, C$30.49, Sector Performer) Savanna Energy Services Corp. (2g) (SVY-TSX, C$5.95, Sector Performer) Semafo Inc. (2a, 2c, 2e, 2g) (SMF-TSX, C$7.57, Sector Outperformer) Sherritt International Corporation (2g) (S-TSX, C$6.62, Sector Performer) Shoppers Drug Mart Corporation (2g) (SC-TSX, C$34.50, Sector Performer) Silver Standard Resources Inc. (2a, 2c, 2e, 2g) (SSRI-NASDAQ, US$18.41, Sector Underperformer) Silver Wheaton Corp. (2a, 2c, 2e) (SLW-TSX, C$20.52, Sector Outperformer)
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
71
Important Disclosure Footnotes for Companies Mentioned in this Report that Are Covered by CIBC World Markets Inc.: (Continued) Stock Prices as of 06/16/2010: Silvercorp Metals Inc. (2g) (SVM-TSX, C$6.97, Sector Performer) Sino-Forest Corporation (2a, 2c, 2e, 2g) (TRE-TSX, C$17.10, Sector Performer) Sprott Inc. (2g) (SII-TSX, C$3.44, Sector Performer) Sun Life Financial Inc. (2a, 2c, 2e, 2g, 7) (SLF-TSX, C$30.61, Sector Performer) Suncor Energy Inc. (2a, 2e, 2g, 7, 9) (SU-TSX, C$34.48, Sector Outperformer) Talisman Energy Inc. (2a, 2e, 2g, 7) (TLM-TSX, C$18.26, Sector Outperformer) Taseko Mines Limited (2g) (TKO-TSX, C$5.23, Sector Outperformer) TD Bank (2a, 2c, 2g, 3a, 3c, 7) (TD-TSX, C$73.48, Sector Outperformer) Teck Resources Limited (2g, 7, 9, 12) (TCK.B-TSX, C$36.50, Sector Outperformer) TELUS Corporation (2a, 2c, 2e, 2g, 7, 13) (T-TSX, C$39.24, Sector Outperformer) The Forzani Group Ltd. (2g) (FGL-TSX, C$16.79, Sector Outperformer) Thompson Creek Metals Company, Inc. (2g) (TCM-TSX, C$10.22, Sector Performer) Tim Hortons, Inc. (2a, 2e, 2g) (THI-TSX, C$34.81, Sector Performer) Toromont Industries (2a, 2e, 2g) (TIH-TSX, C$24.36, Sector Performer) Total Energy Services (2g) (TOT-TSX, C$8.04, Sector Performer) TransAlta Corporation (2a, 2b, 2c, 2d, 2e, 2f, 2g, 9) (TA-TSX, C$21.55, Sector Performer) TransCanada Corp. (2a, 2c, 2e, 2g, 7) (TRP-TSX, C$36.90, Sector Outperformer) Trican Well Service Ltd. (2g) (TCW-TSX, C$13.94, Sector Outperformer) Trinidad Drilling Ltd. (2a, 2c, 2e, 2g, 7) (TDG-TSX, C$5.25, Sector Performer) Uranium Energy Corp. (2g) (UEC-AMEX, US$2.99, Sector Outperformer) Uranium One Inc. (2a, 2c, 2e, 2g) (UUU-TSX, C$2.19, Restricted) UTS Energy Corporation (2g) (UTS-TSX, C$2.40, Sector Outperformer) Yamana Gold Inc. (2g) (AUY-NYSE, US$10.48, Sector Underperformer)
Companies Mentioned in this Report that Are Not Covered by CIBC World Markets Inc.: Stock Prices as of 06/16/2010: Baytex Energy Trust (BTE.UN-TSX, C$33.36, Not Rated) Bonavista Energy Trust (BNP.UN-TSX, C$24.89, Not Rated) Costco Wholesale Corp. (COST-NASDAQ, US$59.16, Not Rated) Dollar General (DG-NYSE, US$30.00, Not Rated) Dorel Industries Inc. (DII.A-TSX, C$36.00, Not Rated) Home Depot (HD-NYSE, US$32.26, Not Rated) Niko Resources Ltd. (NKO-TSX, C$102.94, Not Rated) Power Corporation of Canada (POW-TSX, C$26.63, Not Rated) Power Financial Corporation (PWF-TSX, C$28.71, Not Rated) Reitmans (Canada) Ltd. (RET-TSX, C$16.90, Not Rated) Sobeys Inc. (SBY-TSX, C$57.95, Not Rated) Target Corp. (TGT-NYSE, US$54.60, Not Rated) Wal-Mart (WMT-NYSE, US$51.64, Not Rated) Important disclosure footnotes that correspond to the footnotes in this table may be found in the "Key to Important Disclosure Footnotes" section of this report.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
72
Key to Important Disclosure Footnotes: 1 CIBC World Markets Corp. makes a market in the securities of this company. 2a This company is a client for which a CIBC World Markets company has performed investment banking services
in the past 12 months. 2b CIBC World Markets Corp. has managed or co-managed a public offering of securities for this company in the
past 12 months. 2c CIBC World Markets Inc. has managed or co-managed a public offering of securities for this company in the
past 12 months. 2d CIBC World Markets Corp. has received compensation for investment banking services from this company in
the past 12 months. 2e CIBC World Markets Inc. has received compensation for investment banking services from this company in the
past 12 months. 2f CIBC World Markets Corp. expects to receive or intends to seek compensation for investment banking services
from this company in the next 3 months. 2g CIBC World Markets Inc. expects to receive or intends to seek compensation for investment banking services
from this company in the next 3 months. 3a This company is a client for which a CIBC World Markets company has performed non-investment banking,
securities-related services in the past 12 months. 3b CIBC World Markets Corp. has received compensation for non-investment banking, securities-related services
from this company in the past 12 months. 3c CIBC World Markets Inc. has received compensation for non-investment banking, securities-related services
from this company in the past 12 months. 4a This company is a client for which a CIBC World Markets company has performed non-investment banking,
non-securities-related services in the past 12 months. 4b CIBC World Markets Corp. has received compensation for non-investment banking, non-securities-related
services from this company in the past 12 months. 4c CIBC World Markets Inc. has received compensation for non-investment banking, non-securities-related
services from this company in the past 12 months. 5a The CIBC World Markets Corp. analyst(s) who covers this company also has a long position in its common
equity securities. 5b A member of the household of a CIBC World Markets Corp. research analyst who covers this company has a
long position in the common equity securities of this company. 6a The CIBC World Markets Inc. fundamental analyst(s) who covers this company also has a long position in its
common equity securities. 6b A member of the household of a CIBC World Markets Inc. fundamental research analyst who covers this
company has a long position in the common equity securities of this company. 7 CIBC World Markets Corp., CIBC World Markets Inc., and their affiliates, in the aggregate, beneficially own 1%
or more of a class of equity securities issued by this company. 8 An executive of CIBC World Markets Inc. or any analyst involved in the preparation of this research report has
provided services to this company for remuneration in the past 12 months. 9 A senior executive member or director of Canadian Imperial Bank of Commerce ("CIBC"), the parent company
to CIBC World Markets Inc. and CIBC World Markets Corp., or a member of his/her household is an officer, director or advisory board member of this company or one of its subsidiaries.
10 Canadian Imperial Bank of Commerce ("CIBC"), the parent company to CIBC World Markets Inc. and CIBC World Markets Corp., has a significant credit relationship with this company.
11 The equity securities of this company are restricted voting shares. 12 The equity securities of this company are subordinate voting shares. 13 The equity securities of this company are non-voting shares. 14 The equity securities of this company are limited voting shares. C97 CIBC World Markets Inc. is an advisor to Quarda FNX Mining in a JV agreement with State Grid.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
73
CIBC World Markets Inc. Price Chart
For price and performance information charts required under NYSE and NASD rules, please visit CIBC on the web at http://apps.cibcwm.com/sec2711 or write to CIBC World Markets Inc., Brookfield Place, 161 Bay Street, 4th Floor, Toronto, Ontario M5J 2S8, Attn: Research Disclosure Chart Request.
CIBC World Markets Inc. Stock Rating System
Abbreviation Rating Description
Stock Ratings
SO Sector Outperformer Stock is expected to outperform the sector during the next 12-18 months.
SP Sector Performer Stock is expected to perform in line with the sector during the next 12-18 months.
SU Sector Underperformer Stock is expected to underperform the sector during the next 12-18 months.
NR Not Rated CIBC World Markets does not maintain an investment recommendation on the stock.
R Restricted CIBC World Markets is restricted*** from rating the stock.
Sector Weightings**
O Overweight Sector is expected to outperform the broader market averages.
M Market Weight Sector is expected to equal the performance of the broader market averages.
U Underweight Sector is expected to underperform the broader market averages.
NA None Sector rating is not applicable.
**Broader market averages refer to the S&P 500 in the U.S. and the S&P/TSX Composite in Canada. "Speculative" indicates that an investment in this security involves a high amount of risk due to volatility and/or liquidity issues. ***Restricted due to a potential conflict of interest.
Ratings Distribution*: CIBC World Markets Inc. Coverage Universe
(as of 16 Jun 2010) Count Percent Inv. Banking Relationships Count Percent
Off The Press — Collective Research Series Sector includes the following tickers: (none).
*Although the investment recommendations within the three-tiered, relative stock rating system utilized by CIBC World Markets Inc. do not correlate to buy, hold and sell recommendations, for the purposes of complying with NYSE and NASD rules, CIBC World Markets Inc. has assigned buy ratings to securities rated Sector Outperformer, hold ratings to securities rated Sector Performer, and sell ratings to securities rated Sector Underperformer without taking into consideration the analyst's sector weighting.
Important disclosures required by IIROC Rule 3400, including potential conflicts of interest information, our system for rating investment opportunities and our dissemination policy can be obtained by visiting CIBC World Markets on the web at http://researchcentral.cibcwm.com under 'Quick Links' or by writing to CIBC World Markets Inc., Brookfield Place, 161 Bay Street, 4th Floor, Toronto, Ontario M5J 2S8, Attention: Research Disclosures Request.
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
CIBC's CIO Roundtable - Volatility And Slower Growth - June 16, 2010
75
Legal Disclaimer (Continued)
without the prior written permission of CIBC World Markets is prohibited by law and may result in prosecution. CIBC World Markets Inc. is a wholly-owned subsidiary of Canadian Imperial Bank of Commerce. Canadian Imperial Bank of Commerce is a related issuer of CIBC World Markets Inc.