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Gordon Pape
Gordon Pape

Let The Winners Run

Contributing editor Tom Slee is with us this week with some thoughts on why markets are calm now, and why some anxieties are overstated. He also reviews his successful IWB Growth Portfolio. Tom managed millions of dollars in pension money during his career and is an expert on taxation. Here is his report.

Talk about staying power! Here we are racking up record highs in the sixth year of a bull market, and stocks remain remarkably stable. Most investors seem quietly confident. Some Federal Reserve policy makers even accused investors of being complacent, as though it was a bad thing. Presumably our central bankers would prefer tumult, fluctuating volumes, and volatile prices. My own feeling is the markets are basically calm because people have been encouraged by the steady economic recovery. One thing is certain: This market can take bad news in its stride. Just look at what was thrown at it during the last few weeks.

First of all, a serious outbreak of hostilities in Gaza was quickly followed by sharply increased tension in the Ukraine. On July 10 the fragile European banking system was rocked by reports of serious financial difficulties at Banco Espirito Santo, one of Portugal's largest financial institutions. There was talk of a ripple effect in the EU and other latent problems. Eventually Espirito reported a US$5 billion loss for the quarter, and the stock dropped more than 60%. Elsewhere, Argentina defaulted on its sovereign debt, raising fears of a currency devaluation and even social unrest.

Closer to home, Fed Chair Barbara Yellen warned about parts of the stock market being "overstretched." Not too long ago, any one of these events would have triggered a full-blown crisis and sent stocks plunging. Not this time around. Except for one small correction, stock exchanges in New York and Toronto shrugged off all the bad news. The markets have underlying strength because of several positive undercurrents at work.

First and foremost, second-quarter corporate earnings are running ahead of even upgraded expectations. As I write, 228 of the S&P 500 companies have reported earnings, and 79% beat forecasted earnings, while 66% surpassed revenue expectations.

There is a steady demand for equities. Institutions have been treating market pullbacks as buying opportunities. According to Jim Paulsen, chief investment strategist at Wells Capital Management, investors are learning that it's a loser's game to sell on bad news.

Most important, we are in the midst of a bond market rally that has experts scratching their heads. Interest rates were supposed to climb as the U.S. Federal Reserve reduced its program of quantitative easing. That has not happened. Ten-year Treasury notes were recently yielding 2.46%, down significantly from 3.0% at the end of 2013, primarily because the Chinese government has been buying U.S. government issues at the fastest rate on record. The Chinese increased their holdings of Treasury debt by US$107.21 billion during the first five months of 2014 and now own US$1.27 trillion, or about 10.6% of the entire market.

There is also downward pressure on European interest rates. So much so, the European Central Bank introduced a negative interest rate policy on some of its deposits. Germany's two-year bonds yield -0.002%, as money floods into this relatively safe haven, while fears mount that sanctions against Russia are likely to backfire and cause deflation. Investors are paying banks to hold their money or shifting it to North America and putting even more downward pressure on our domestic rates.

I think this cheap money, especially now that it's likely to continue for the foreseeable future, has put a floor under our stock market. Low interest rates spur the housing markets and consumer spending, which in turn boost corporate revenues. At the same time, companies are able to reduce financing costs. As a result, earnings grow more rapidly. Meanwhile, institutions are forced into the stock market and increase their common share weightings in order to earn an acceptable return.

Eventually, of course, inflation rears its ugly head, and the central banks put on the brakes. Rates rise, and there is a stock market correction. At the moment, however, there is no sign of this happening, and we now have another positive factor to consider.

Central bankers are coming to the conclusion that when interest rates eventually move up to "normal" levels, they are likely to stabilize well below the rates we were accustomed to. The 2008 crash and massive financial adjustments made to repair the damage caused structural changes. Bank of England Governor Mark Carney thinks British rates are likely to stabilize around 2.5% compared with the 5% previous norm. Bank of Canada Governor Stephen Poloz believes that our norm will be lower than the 4% historical average. That has to be a plus for stocks.

All things considered, therefore, I am inclined to remain fully invested at this stage and let stocks that are doing well run unless they are obviously overpriced. It's the approach I have taken in the semi-annual review of our Growth Portfolio, which follows. Incidentally, you might be interested to know that the few bull markets that made it past their fifth birthday, like the one we are in, produced on average a 26% growth in their sixth year. I would not set a lot of store by that statistic, but it does suggest we have momentum on our side.

The Growth Portfolio was launched in August 2012 with an initial investment of $10,000. It has generated a 56% total return based on the original amount that includes a $5,087 capital gain and $649 of dividends, $139 of which were earned from stocks no longer in the portfolio.

All of the investments performed well during recent months with the exception of Michael Kors Holdings Ltd. (NYSE: KORS). After soaring almost 300% following its initial offering in December 2011, this juggernaut finally hit a wall in June. Understandably nervous after the impressive run up, investors were a little disappointed by the company's fourth-quarter 2014 profit margins.

The selloff though was triggered by an article in The Wall Street Journal, pointing out that high-end accessory consumers are extremely fickle. Successful luxury brands have to be almost unique, certainly uncommon. Kors therefore, is going to find it increasingly difficult to maintain its special status while expanding department store sales and opening more outlets. To quote the WSJ: "For a luxury brand like Kors, there are few fates worse than ubiquity." Another problem is that a revitalized Kate Spade & Co. (NYSE: KATE), previously Liz Claiborne, is moving upscale and snapping at Kors' heels. Inevitably, a lot of investors overreacted and hit the panic button.

Michael Kors stock has dropped 20% from a high of US$101 and closed Friday at US$79.26, where I think it has upside potential. This is a well-managed, imaginative company still in its early stages that has only scratched the Asian market. (More complete review follows.) Therefore, I am going to retain Kors and make no changes to the portfolio at this time.

Here is how our Growth Portfolio stands as of August 1, 2014. Note that Canadian and U.S. currencies are treated at par.

IWB Growth Portfolio (a/o August 1, 2014)



Total Shares

Initial Price

Book Value

Current Price

Market Value

Dividends Retained

Total Return


















































































* August 2012. Includes a $5,087 capital gain and $649 of dividends, $139 of which were earned from stocks no longer in the portfolio.

A word of caution: Any growth-oriented portfolio entails some risk, so investors who are unable to handle that should not try to replicate this list of holdings, even though they are mainly blue chips.

Here's a rundown on our holdings and some comments on how they are performing.

Alimentation Couch-Tard Inc. (TSX: ATD.B, OTC: ANCUF). This extremely successful retailer has expanded rapidly by acquiring competitors. Current organic growth is impressive, and I expect management to continue mopping up rival convenience store chains in a still-fragmented industry.

Currently operating 8,507 outlets in Europe and North America, Alimentation reported fourth-quarter fiscal 2014 earnings of $0.22 a share versus $0.20 the year before and in line with expectations. At the same time, the quarterly dividend was raised to $0.16 per annum, the third upward revision in the last 12 months. Same-store results were strong, and we should see revenue growth in fiscal 2015 as well as improved profit margins, especially in the fresh food category, generating earnings of about $1.60 a share. The balance sheet has capacity for further acquisitions, and there is talk of Shell's 400 Norwegian gas station outlets being a target. I am maintaining our $37 target.

Stella-Jones Inc. (TSX: SJ). This is another company that has grown rapidly in recent years. This pressure-treated wood producer supplies railway ties and utility poles as well as construction timbers. As part of an continuing acquisition program, management recently purchased Alabama-based Boatright Railroad Products with sales of US$73.5 million. Stella-Jones is in the right business at the right time. Major railroads are upgrading their systems, and there is continuing demand for utility poles as communities repair aging infrastructure.

Earnings of about $1.65 a share are expected in 2014, with a substantial 20% plus increase to the $2 range next year. A recent pullback has resulted in the stock trading at its lowest valuation in almost a year and a half. I have a $36 target.

Simon Property Group Inc. (NYSE: SPG). The largest fully integrated real estate company in the United States currently owns 325 properties spread across North America and Asia and plans to spin off some of these to its shareholders. Revenues of US$5.2 billion were booked last year and are expected to grow at about 7% per annum. Cash flow per share, the best way to measure Simon, could exceed US$9 a share in 2014, and the company's occupancy rates are close to 97%.

The thing that I like most about Simon is its steadily increasing cash flow, which could climb to almost US$10 a share next year. I think that we should see the stock at US$190.

WSP Global Inc. (TSX: WSP). This has become one of the world's leading professional services companies, employing 14,500 engineers, architects, and scientists through 300 offices across 35 countries. First-quarter 2014 earnings of $0.33 a share were up from $0.28 last year and beat the forecasted $0.29. A few months ago WSP acquired Focus Group, an 1,800-employee engineering firm based in Alberta.

The company is experiencing strong organic growth in China, Europe, and the Middle East. Canadian margins have been under pressure, but management is taking steps to reduce costs in these operations. Looking ahead, we should see further expansion resulting from increasing profits and further acquisitions. Earnings of $1.85 a share are expected this year, with an increase to $2.30 in 2015. I have a $42 target.

TransForce Inc. (TSX: TFI). This full-service transportation provider has been very busy on the acquisition front this year and has so far spent $1.2 billion to buy six separate businesses. Second-quarter 2014 profit of $0.48 a share was well above the $0.42 consensus forecast. Operating income increased 28% year over year thanks to improved margins in the Package and Courier division. As a result the company is now on track to make $1.75 a share in 2014 and as much as $2.15 next year. I have set a new target of $32, although the stock may move sideways for a while as investors wait for TFI to digest its acquisitions.

New Flyer Industries Inc. (TSX: NFI). This manufacturer of heavy-duty transit buses is having an excellent year. Solid first-quarter earnings of $36.8 million beat the $25 million consensus estimate. Deliveries of 554 new units were in line with expectations, and total backlog was unchanged at $3.7 billion. Later, the company reported that aftermarket parts shipments were up 55% year over year.

The stock has performed well recently, and I think there is more upside potential. The target has been adjusted to $15.

Michael Kors Holdings Ltd. (NYSE: KORS). Latest quarterly earnings of US$0.78 a share significantly exceeded the US$0.64 guidance and $0.68 consensus forecast. The problem has been that the stock became overpriced. At one stage it was trading at 34 times trailing earnings, which is why we recommended taking 50% of your profits when Kors was at $97 in late February. There was bound to be a correction. Now, however, with expected earnings of US$4.25 in fiscal 2015, the shares represent good value. The fundamentals are impressive. For example, latest-quarter revenues of US$917 million were up 12% from the previous year while same-store sales jumped 26%. I have a US$95 target.

United Health Group Inc. (NYSE: UNH). Strong government program growth and tighter cost controls are boosting the bottom line, while management of this massive health care company views Brazil as an attractive market. We should see earnings of US$6.25 a share in 2015 and the shares at US$95.

About the author:

Gordon Pape
Gordon Pape is the best-selling author/co-author of many acclaimed investment books, including the recently-published Sleep-Easy Investing (Viking Canada ). He is also publisher and editor of five investment newsletters, including the Internet Wealth Builder, Mutual Funds Update, The Income Investor, and The Canada Report, which was created specifically for U.S. residents interested in investing in Canada . He is a columnist for several magazines and websites and a frequently quoted media source. He has been a featured speaker at numerous events including the World Money Show in Orlando . His websites can be found at www.BuildingWealth.ca and www.TheCanadaReport.com.

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