QE3 not imminent, but not ruled out

The past week will likely be remembered as one that started and finished quietly, but made a lot of noise in between from an economic perspective. And most of that noise was caused by the Federal Reserve which held its Open Markets Committee meeting on Tuesday and released stress tests on 19 U.S. financial institutions early due to a leak at JPMorgan Chase.

First, Ben Bernanke and the FOMC did the expected by keeping the overnight lending rate in the U.S. unchanged and while economic data has improved, the Committee still noted that macro environment was challenging and reiterated that they did not see interest rates changing until later in 2014.

However, investors were waiting to see if Bernanke might make mention of another possible round of Quantitative Easing, or QE3, that would help the housing market. In the end, there was no mention of QE3 which sent the U.S. dollar higher and knocked the wind out of precious metal prices. We still can’t rule out QE3 at this stage, but it appears it won’t materialize in the immediate future.

The Federal Reserve also released its stress tests on 19 financial institutions which showed that most companies met the minimum requirements in terms of capital set out by the Fed with the exceptions of Citigroup Inc., Ally Financial Inc., SunTrust Banks Inc., and MetLife. However, failing the stress tests didn’t seem to bother investors as their share prices remained relatively intact.

Apple was once again in the news as the company’s share price broke through the US$600 level for the first time likely due to anticipated sales from what’s being called “the New iPad” which went on sale on Friday.

While the U.S. may have had a quiet Friday, BCE and Astral Media created a lot of noise in Canada with the announcement that BCE would acquire all outstanding shares of Astral in a big M&A deal worth $3.38 billion.

This follows rumours earlier in the week that Viterra may be purchased in a joint bid by Glencore International, Agrium Inc., and Richardson International after management initiated steps in a potential sales process.

Oil prices were little changed as there were few headlines out of the Middle East while precious metal prices were under pressure thanks to U.S. dollar strength. Even with that strength the loonie still traded close to US$1.01.

Will Guiness profits soar?

It’s that time of year again when everyone on the planet suddenly becomes Irish. Considering that many people associate big celebrations with Saint Patrick’s Day, otherwise known as St. Party’s Day, is it fair to assume that Saint Patrick’s Day is the largest beer consumption day of the year in the U.S.?

The answer is no, and in fact it’s not even in th top 10. According to statistics collected by The Nielsen Company on the number of cases of beer purchased for two weeks prior to a specific holiday, sales of beer were highest for the 4th of July, followed by Memorial Day and then Labour Day.

Somehow Saint Patrick’s Day is beaten by Easter! Now then, most of you are probably thinking that sales of Guinness must do well on Saint Patrick’s Day, and you would be correct as estimates suggest that consumption of Guinness increases 350% on Saint Patrick’s Day alone.

Can you take advantage of this in the stock market? The company that owns the Guinness brand is called Diageo plc and you can buy the ADR of the stock on the NYSE (ticker DEO.N). However, Diageo owns many brands of spirits, beers, and wines, so Saint Patrick’s Day sales of Guinness will likely not make a material impact to a company that makes billions of dollars/pounds every year.

Other beer brands owned by Diageo include Harp Lager, Kilkenny, Smithwick’s Ale, Tusker Lager, Red Stripe Lager, Satzenbrau, Senator Keg and Windhoek Lager.

Trading week ahead

As we look forward to next week, we might actually find news out of Europe to be relatively quiet Greece had its bailout package approved, so European concerns have died down, but only for the time being as troubles for other European countries and European economic growth are bound to resurface in the future.

If we look to the U.S. and Canada, we also find a quiet economics calendar. However, a common theme amongst the expected releases in the United States is housing. Recent data for Housing Starts, Existing Home Sales and the NAHB Index will all be released next week which will give us a good idea of how volumes and sentiment are behaving. However, they will not necessarily give us a great deal of insight on what’s happening to home prices which we tend to glean from the S&P/Case-Shiller Index due out on March 27.

In Canada, we’ll get an update on retail sales and the Bank of Canada (BOC) will be watching the inflation report due out on Friday. Core inflation is forecast to be 2.2% which is still within the BOC’s targeted 1% to 3% band.

Earnings releases in the U.S. will remain quiet as we only expect a few large cap companies to announce results including Oracle Corp, General Mills, FedEx Corp, and NIKE Inc. Canadian earnings will also be quiet amongst larger cap names, but there will be a number of reports issued from small cap companies predominantly in the Materials and Energy sectors.

Commodity investors will continue to watch the U.S. dollar, which has strengthened since the beginning of March and has been partially responsible for the pull back in precious metal and oil prices since their recent peaks.

Precious metal investors will also keep an eye on economic data to see if any discussion of Quantitative Easing (QE3) resurfaces from the Federal Reserve. Canadian currency traders will be focused on inflation data to see if the Bank of Canada’s next move on rates might be biased higher, thus supporting the loonie which remains above par.

Question of the week

The Canadian banks recently reported fiscal Q1/12 earnings. Are they still good investments?

Yes, Canadian banks completed their first quarter reporting season last week, and overall results amongst the largest six banks in Canada were either in line or exceeded Consensus estimates.

We noticed some similar trends within the bank group such as reasonably strong retail banking results in a difficult operating environment, stable wealth management results, and weakness in wholesale banking although trading revenues at some banks did improve quarter over quarter.

We also saw three of the big six banks raise their dividends. TD Bank’s quarterly dividend increase from $0.68 to $0.72 was expected by most analysts while the increases from Royal Bank and Bank of Nova Scotia were pleasant surprises to some investors. Royal Bank increased its quarterly dividend from $0.54 to $0.57 while Scotia increased its dividend from $0.52 to $0.55.

All banks reiterated that their exposure to European sovereign or corporate debt was either minimal or non-existent.

To answer the question of whether Canadian banks are still good investments, we must first state that there are a number of ways to analyze these equities.

The best method of analysis is always subject to personal opinion; however, we like to look at Price to Earnings Growth or the PEG ratio where you compare the future P/E multiple to forecasted earnings growth. In other words, what are you paying for the earnings growth a company hopes to generate? If a PEG ratio is closer to zero a stock can be considered cheap, if it is close to one it is neither cheap nor expensive, and if it is above two it can be considered pricey.

Based on current estimates for 2012, the PEG ratios fall between 1.2 and 1.9. Therefore, we cannot say that the Canadian banks are really cheap; however, we also can’t say that they’re terribly expensive based on the PEG ratio alone.

Admittedly, due to a nice run since the beginning of the year, some of the banks are getting “more” expensive than they once were, but considering the cash they are once again returning to shareholders in the form of dividend increases, we believe that Canadian banks are still investments that should be part of a balanced, diversified portfolio.

Gareth Watson is the Vice President, Investment Management & Research at Richardson GMP in Toronto. This team of research experts is responsible for monitoring and interpreting economic, geo-political situations, current market environments and trends. @Gareth_RGMP