Opportunities in the sideways market

There’s nary a bull or bear to be seen on Bay Street these days. That’s because we’re in a sideways market. That was the message Kim Shannon, president and chief investment officer of Sionna Investment Managers, presented at the firm’s Financial Market Review in Toronto yesterday.

It’s a challenging environment but there are still some opportunities, she said, adding that investors need to be “cautious and take the path of low-cost investments and take advantage of bargains in the energy space.”

In the fixed income space, bond yields have been low and, in January of this year, hit lowest they’ve been (at 1.79%). Shannon said this leaves investors wondering if that’s the lowest they’ll go and if the fixed income market will rally.

As for equities, these are still the best option for generous returns, she said. “It is your best solution for getting decent returns going forward.”

Small cap While equities are an option for returns, large caps aren’t the only option. Teresa Lee, portfolio manager and managing director, investments, with Sionna, explained why investors should consider small cap stock, beginning with a debunking of three myths about small caps.

Myth 1: Small caps are lower-quality business. Small cap companies have a better balance sheet with similar levels of profitability to large caps. For example, according to Sionna’s research, the debt to equity ratio for its small cap fund is 0.6, compared with 1.1 for large cap.

Myth 2: Small cap stocks are economically sensitive. Although small caps perform similarly to large caps during a recession, historical data have shown that after a recession they tend to outperform. According to research from BMO showing the average performance of small cap stocks during recessions from 1970 to the present, small caps outperform 15%, on average, coming out of a recession. “You can buy a better-quality business in the small cap market,” Lee said.

Myth 3: Small caps are riskier. While Lee admitted that small caps are riskier, she said the “small cap volatility and risk can be reduced with research and active management. If you want higher returns, you have to take on more risk.”

She concluded with a simple message: “Small is beautiful.”

Click through to read about Sionna’s “love affair with dividends“…

Dividends Portfolio manager Marian Hoffman then explained Sionna’s love affair with dividends and that dividend payers outperform over the long term. And, she added, in a sideways market, dividends can account for up to 90% of total return.

But while there are an increasing number of companies paying dividends, Hoffman explained that dividends do not come cheap, as they impact on valuations, and all dividends are not equal.

She said it’s important to distinguish the quality of the dividend’s yield and for investors thinking about dividend-paying stocks to consider the following:

• the health of the underlying business (is the business growing?);
• the payout ratio (how much earnings are being paid out in dividends?);
• the strength of the business’s balance sheet (is there a huge amount of debt?); and
• management’s capital allocation policy (is this management team committed to returning cash to shareholders?).

Hoffman said there are some strong tailwinds for dividend strategy: low interest rates, favourable demographics, preference for income in economic uncertainty and cash-rich companies looking for places to deploy.

“We’re not saying dividend strategy is dead or over,” she said. “Just watch the fundamentals and don’t pay any price for yield.”

Gold Mel Mariampillai, a portfolio manager with Sionna, ended the session with a discussion on gold. Although Warren Buffett’s claim is that gold is useless, gold is not totally a lost cause.

Gold has been used as a form of currency and continues to be used in parts of Asia and the Middle East.

And, as the government debt continues to grow and “no one knows the impact these increases in debt will have, gold may have a role to play in the future if the risks to paper money are so high,” said Mariampillai.

In fact, according to the 2011 Bank of England Stability Paper, our fiat currency-based system is inherently unstable when compared to a gold-based system: in the gold-based system from 1948 to 1972, there were 0.1 banking crises per year; in the fiat-based system from 1973 to 2009, that number increased to 2.6. Although the report did not suggest a return to the gold standard, Mariampillai said that it’s certainly a sign that banks are concerned.

Mariampillai said that after years of selling gold holdings, central banks are starting to purchase gold—particularly those in the emerging market countries.

Mariampillai said that Sionna’s position on gold is to market weight gold in the large cap fund, invest in inexpensive high-quality companies and participate if gold prices rise.