Rate trend isn’t your friend: fund manager

U.S. stocks have been on fire since Donald Trump’s victory in the November election, with the market’s strength being led by financials.

Canadian banks and insurance companies also got a boost, but another big piece of the domestic equity pie, energy, has faltered, causing the S&P/TSX Composite Index to lag.

Norman Levine, managing director at Torontobased Portfolio Management Corp., which has more than $600 million in assets under management for high net worth individuals and families, believes U.S. stocks have risen to the point that valuations appear to be ahead of the fundamentals.

“So we wouldn’t be surprised to see some ongoing near-term weakness to bring valuations back in line,” he said.

But Levine’s biggest concern is interest rates, as both bear markets and corrections are cyclical, but the generational shift to higher rates represents a secular move.

Interest rates have generally been trending downward since 1982, but there is an expectation that if 10-year U.S. treasuries move above three per cent, the cycle will have officially been broken.

“That has lots of implications for the bond market, and eventually the stock market as well,” Levine said. “Usually, when interest rates start going up, it’s a sign of an improving economy, increasing demand for credit, and probably higher inflation. But if interest rates keep going higher along with inflation, that then shuts down the stock market.”

It’s early days for the interest rate move, so for now, the shift is positive for equities. But Levine is keeping a closer eye on these trends, rather than focusing on near-term moves in the stock market.

This theme is reflected in client portfolios, which have high weightings in insurance companies and financials in general.

However, Levine is favouring more exposure to U.S. banks and other financials relative to Canadian companies, which are less sensitive to changes in interest rates.

“If the U.S. economy strengthens a bit, that will lead to stronger sales and earnings, which will help justify U.S. stock prices,” Levine said. “Canada is different because there isn’t a whole lot left after financials and commodities, so it’s more suited to stock picking.”

One such name that Levine has owned for six years, and considers a core longterm holding, is (BAD/ TSX).

North America’s largest high-pressure water excavating company has utilities and energy companies as its primary customers, but exclusively served the Canadian oilpatch when it began.

Levine noted that Badger is now much more diversified, with the U.S. accounting for about two-third of revenues, and energy representing about 25 per cent of revenues.

“The Street still views it as an energy-related stock, but it’s not as cyclical as it was, so we think that is an opportunity,” he said. “Initially it was a yield stocks during its time as an income trust, then it transitioned to a value stock, and then it became a growth stock.”

Levine also highlighted SNC-Lavalin Group Inc. (SNC/TSX), one the world’s leading engineering and construction companies, but more importantly for investors, the cheapest one in North America.

“The stock has fallen from its peak near the end of 2016 because SNC indicated it was looking to make a major acquisition, and the market was afraid that would be dilutive to earnings,” he said. “We look at it differently. The company is under-leveraged compared to its competitors, so as long as it doesn’t overpay for something, we view that as positive for the stock.”

The market certainly seems to like SNC’s potential US$2.6 billion takeover of WS Atkins PLC of the U.K., sending the stock higher in recent days as the companies discuss a deal.

“Investors aren’t paying a lot for this company, and they grow the dividend every year,” Levine added. (PKI/TSX) is another portfolio holding that’s been on the hunt for deals, as the fuel distribution company whose biggest business is gas stations, has established itself as a growth-by-acquisition story.

Levine noted that while most of its assets are in Western Canada, Parkland is making a bigger push to become a cross-Canada player.

Last year, the company bought Pioneer Energy in Eastern Canada, and Chevron gas stations in Western Canada. Now it’s poised to acquire the Canadian part of

in a deal with Alimentation CoucheTard Inc.

Levine noted that Parkland has focused on gas stations, but is now becoming more interested in convenience stores, too.

He also pointed out that despite all these acquisitions, there are more major deals possible in both Canada and the northern U.S.

“Most of their gas stations are in rural markets, so they still have urban markets to move into,” Levine said. “The market rewards them whenever they do a good acquisition.”