Author: David Pett

The euro may be weaker due to the Greek crisis, but it has held up relatively well considering the beating Greece's bond markets have taken over the past couple of weeks, Adam Cole, global head of FX strategy at RBC Capital Markets says. 

Unless the risk of default in Greece expands throughout the eurozone, chances are the European currency will continue to weather the storm.

"The euro is not pricing in the worst outcome as there is an underlying expectation that Greece will not trigger a systemic crisis far beyond its
borders." Mr. Cole said. "We will not see the euro in free fall unless the periphery risk turns systemic."

Since April 12, Greek 10-year bond spreads over German bunds have risen from 350 basis points to a peak of 826 basis points after Standard & Poors downgraded the country's debt to junk status earlier this week.  

Portuguese spreads have also almost doubled over the same period and Spain's yield spreads hit post European Union highs to reflect growing concerns in each of those two countries that has resulted in lesser downgrades to their credit ratings. 

The euro, however, only lost 1.8% against the U.S. dollar since mid-month, dropping to US$1.31 on Tuesday from US$1.36.

With bond spreads narrowing again and the euro rallying over the past two days, Mr. Cole offered two explanations for the relatively small drop in the currency.

The first is that the euro has been quicker to price in disaster scenarios, having dropped significantly in late December, only to recover modestly and drop again from mid-January to late February. 

"With EUR positioning already at record shorts, the sell-off over the past few weeks has been small in comparison," he wrote.  "This explanation would suggest that downside for EUR would be more limited going forward."

The second explanation reflects the fact the eurozone is made up of 16 sovereign nations, each with its own bond markets, but just one common currency.  

"Greece and Portugal combined are approximately 4.5% of eurozone GDP. Greece, Portugal and Spain are 16%," Mr. Cole noted. 

"As long as Greece remains the only country with a serious risk of restructuring, Greek bonds sell off, but EUR reflects just a fraction of that. As long as the risk of default in Spain is remote, the Eurozone may cope with one errant state."

David Pett

Shares in Canadian Pacific Railway Ltd. are on the move, as the Street shower's the country's second biggest railroad with praise following better-than-expected earnings results announced Wednesday.

Back of above $60, and closing in on a new 52-week high, analysts think CP stock has plenty of upside still to come.

"We consider the strong Q1 results to be a key catalyst for the CP shares – as we believe investors had discounted CP's ability to significantly realign its cost base," Walter Spracklin, an analyst at RBC Capital Markets said in a note to clients.  

Mr. Spracklin maintained his Outperform rating and raised his price target to $70 from $65.

He said he expects substantial upward earnings revisions, leaving his "street-high" 2011 estimate of $4.66 unchanged.

"We are increasing our target multiple on the CP shares to 15x (from 14x) on the back of the improving economy and CP's leverage to this improvement, the analyst  wrote.

Trading at roughly 11x his revised 2011 earnings estimate of $4.65, Raymond James analyst Steve Hansen said CP is trading at a discount to its peers. He increased his price target to $70 from $65 and reiterated his Buy rating,

"Looking forward, sustained potash and coal volumes through 2Q will continue to trounce last year’s paltry comps, in our view," he told clients.

"Healthy merchandise and intermodal improvements, coupled with plenty of idle capacity still in the system, should also facilitate further operating and financial gains."

David Pett

Cisco Systems Inc. shares have been upgraded to Top Pick from Sector Outperform by RBC Capital Markets.

"Strengthening trends across all major business segments combined with consistent execution may enable Cisco's stock to break its relative inline trends with large tech peers," analyst Mark Sue said. 

Mr. Sue said the biggest factor driving his upgrade is the conviction that Cisco has strengthened its position and may be gaining a larger share of corporate
IT spend and carrier capex budgets.

He also raised his 12-month price target to $33 from $30, representing a multiple of 19x his calendar year 2011 earnings per share of $1.75. The current industry mean is 14x.

"We believe CSCO deserves a premium multiple because of its strong cashflow, balance sheet and industry position," the analyst said. 

David Pett

Big trouble at Greystar Resources Ltd. is negatively impacting shares in Colombian gold mining neighbour Ventana Gold Inc. this week, but investors probably have nothing to worry about, Daniel Earle, a TD Newcrest analyst says.

On Monday, Greystar announced that it would be subject to changes in Colombia's mining code, that essentially ban mining in Colombia's "Paramo" ecosystem. Greystar's Angostura gold-silver project infringes on that area. 

While Greystar stock has plummeted more 40% on the news, shares in Ventana Gold, whose flagship La Bodega project is adjacent to Angostura, have also been hit, falling more than 5% since last Friday.   

Time will tell whether the sell off in Ventana was warranted, but according to Mr. Earle, the new regulation and environmental request is not applicable to La Bodega based on the much lower elevation of the project.

"We understand that the highest point on the La Bodega concession where the La Bodega zone butts up against the Greystar property boundary is a little under 2,900m," he said in a note to clients, maintaining his Speculative Buy rating and $12 price target.

"Furthermore, we note that the La Bodega property has an approved environmental management plan that provides the company with protection from subsequent environmental legislation.

Mr. Earle said he spoke with Ventana management, who told him they have been aware of this specific issue for some time and believe there is no carry-over impact for La Bodega. 

David Pett

Canadian National Railway Co. beat expectations when it reported first quarter earnings results Monday after market close, but while many analysts applauded, it didn't save the country's largest railway from at least one downgrade of its shares.  

Tasneem Azim, an analyst at UBS AG, cut his rating on CN to Neutral from Buy, telling clients that tougher comparables in the second half of 2010 and first half of 2011 combined with a premium valuation will hinder future upside.

"We would be inclined to be more constructive on the shares with a pullback in valuation," he said. 

The analyst did raise his price target to $67 from $65 to reflect a
higher target multiple of 14.5x from 14x. Mr. Azim said the increased target is better aligned with historical mid-cycle multiples and also highlight's CN's improved
guidance.

Benoit Poirier, an analyst at Desjardins Securities, is far more bullish in the wake of yesterday earnings beat, raising his recommendation to Buy from Hold and increasing his price target to $71 to $62.

"It's not too late to hop on the train," he said in a note to clients. 

David Pett

The crisis in Greece is expected to weigh on equity markets for some time yet, but with earnings season kicking off impressively last week and set to continue, it may not be enough to derail equity markets, Ed Solbach, a strategist at Desjardins Securities said. 

"Earnings growth that is even better than our optimistic outlook projections gives us increased confidence that we will achieve our 2010 equity target of 13,200 for the S&P 500 and 14,200 for the TSX," Mr. Solbach said in a note to clients.

Of the 174 companies listed on the S&P 500 that have reported first quarter earnings, 84% have beaten earnings expectations. That's up from 80% in the third quarter of 2009 and fourth quarter of 2009 and far exceeds the average historical earnings beat of 61%.  Earnings have also increased 50% from the first quarter of 2009, representing record growth.  

"The increase is the highest in at least 40 years, and even stronger than the incredible 39% growth that was forecast. 

"Revenues are also up 11% from last year, so the previous argument that earnings growth was all due to cost-cutting is no longer valid," he said. 

So far, the impressive earnings growth has easily offset negative news of Greece's debt troubles and also the SEC's fraud allegations against Goldman Sachs. Last week, the S&P 500 climbed 2.1% and the TSX added 1.4%.

With both benchmarks up 84% and 67% respectively from their March 9 lows, but still well off their pre-Lehman highs, Mr. Solbach said stocks on both sides of the border are undervalued.

If earnings estimates continue to come in better-than-expected, they could hit US$80 per share, he said, which is even higher than recently revised consensus estimates of US$78.

"Over the longer term, stock prices are ultimately valued based on a multiple of earnings, so prices must move up to reflect this higher level of earnings," the analyst wrote.

David Pett

Acquisitions of failed U.S. banks by Bank of Montreal and Toronto-Dominion Bank over the past two weeks may be forcing Royal Bank of Canada to play catch up, Michael Goldberg, an analyst at Desjardins Securities says.  

"With BMO and TD active, there is likely to be increased attention on Royal," Mr. Goldberg said in a note to clients.

"However, this may put pressure on Royal's stock price because it may be viewed as more likely to make a much more significant and dilutive acquisition to strengthen its relatively weak US commercial banking platform."

Late Friday, Bank of Montreal said that Harris Bank, its US commercial banking operating platform, was selected by the Federal Deposit Insurance Corp. bidding process as the buyer of the failed AMCORE Bank of Rockford, Illinois. Harris acquired US$2.5-billion in assets, including US$2-billion of loans, and assumes US$2.1-billion of deposits.

A week earlier, TD said it had been selected as part of a FDIC auction, the buyer of Riverside National
Bank of Florida, First Federal Bank of North Florida and AmericanFirst
Bank, also located in the sunshine state. 

Mr. Goldberg said the BMO deal will likely be viewed as a positive by investors, however, it is not expected to have any material impact on its capital position or earnings.

He added that both the BMO and TD acquisitions demonstrate the willingness of Canadian banks to bolster their U.S.-based operations.

David Pett

Peter Misek at Canaccord Adams downgraded Nokia Corp. from Hold to Sell and slashed his price target from US$15 to US$10 after the company's first quarter results missed expectations across the board.

In a research note titled "Caught between an Apple and a BlackBerry," the analyst noted that while the earnings were only slightly below consensus expectations, Nokia continues to face intense competition in the high end of the smartphone market. It also faces average sales price erosion in the low end of the market.

"With gross margins compressing, we would expect that even with a rebound in revenue, earnings growth will be limited," Mr. Misek told clients.

RBC Capital Markets analyst Mark Sue believes Nokia may have to spend aggressively in the near term to ready its new handset portfolio. He also suggests it might cut pricing on its existing portfolio to maintain unit market share.

“We expect a sharp dip in profitability,” Mr. Sue said in a note. “Nokia dominates with 33% unit market share, and its distribution network is solid. Yet catching up to competitors comes with costs and risks.

The analyst maintained an Outperform rating on Nokia shares but trimmed his target from US$16 to US$15.

Jonathan Ratner

Blame Brazil for the underperformance in emerging market stocks so far this year, says Geoffrey Dennis, an analyst at Citigroup Capital Markets.

While global equities have climbed 4.6%  so far in 2010, emerging market stocks as a whole, are up 4.3%, due primarily to poor performance in Brazil, where the country's top benchmark is down -0.2%. Indeed, Brazil is the second worst-performing emerging market in 2010.

"These trends are a reversal of 2009, when Brazil outperformed Latin America, which outperformed emerging markets, which outperformed the [world stocks]," Mr. Dennis said.  

He said some common arguments thought to explain emerging market underperformance don't add up. In particular, the earnings forecasts in 2010 has been equally strong in developing and developed markets. Meanwhile, emerging countries that have raised rates in this cycle – Israel, Malaysia and India – are outperforming this year.

The fact that the U.S. dollar is barely higher in 2010 also does not explain the emerging market underperformance.

Arguments focused on Brazil, one of the three bigges emerging markets, do hold water, however.  Mr. Dennis said Brazil has been hit hard by nerves ahead of October elections, the focus on the next rate cycle, which has been compounded by the mistake of not tightening in March, and the poor performance of oil and gas giant, Petrobras that has fallen 11% due to concerns of an upcoming equity issuance.

If Brazil is excluded from performance figures, Latin America is up 7.6% year-to date, emerging markets are up 5.3% and world stocks are up 4.9%.

"We remain long-term positive but continue to look for only modest gains in 2010 in Latin America (15-20%)," Mr. Dennis said. 

"We would buy the ‘latest dip’ in markets and expect the underperformance of Brazil, Latin America and GEMs to ease as the year proceeds."

David Pett

The struggling euro could fall as low as US$1.27 sometime later this summer, Ashraf Laidi, chief market strategist at CMC Markets says.

Should it do so, it would represent a total drop of 16% to the greenback since November. While not the worst decline in the the European Union currency, it may be the most troubling given the circumstances behind the fall.

"Never since its inception has the single currency faced serious doubts about the default of its members or its legal framework regarding bailouts," Mr. Laidi said in a note to clients. 

"Keeping aside the potential headwinds emerging from commodities, the
single currency suffers from a fundamental and technical decline."

Mr. Laidi noted that the euro fell 31% between 1999 and 2002, as the result of an excessively high starting price of the currency and prolonged headwinds on Germany and Eurozone from the Asian crisis. The US dollar was also benefiting from robust growth and record high capital flows chasing US technology stocks, he said. 

Meanwhile, in 2005 the 14% euro decline in 2005 was mainly due to U.S. Federal Reserve tightening and the 2005 Homeland Investment Act, which encouraged US multinationals to repatriate profits at slashed tax rates. 

More recently, he said the 24% drop in 2008-09 was from plunging risk appetite and plummeting commodities, to the benefit of the US dollar.

"The current slide in the euro shows more fundamental similarities to the sell-off of 1999-2000 in that it is largely Eurozone-centric, rather than US or global -centric (as was the case in 2005 and 2008)," Mr. Laidi said.

But unlike the case one decade ago, the need for austerity policies in Greece, Portugal and Spain may not be offset by higher demand in Germany and France.

David Pett

By Paul Gardner

Many believe that equity markets are unjustifiable at their present levels given unemployment at cyclical highs and the spectre of continuing economic weakness.

Since March 2009 however we have seen a 70% equity rally and the corollary narrowing in corporate bond spreads as investors accept more risk.

Is this irrational exuberance or rational re-pricing?

We believe this is a rational repricing and that we could expect to see a further 10-15% increase in equity markets over the next 12 months. Investing in equities entails investing in companies first and the economy second.  Companies are impacted by the economy but also adapt and react to it.  

Over the past 12 months many companies have beaten bearish expectations.  Indeed, surprisingly both margins and profits remain healthy relative to other economic cycles.  

We believe the difference this time is that companies shed costs (i.e. jobs) quicker than ever before.  This resulted in a dramatic increase in unemployment in developed economies, which in turn caused economic growth to slow.  Company’s however maintained profitability due to timely inventory management and productivity gains.  The bearish prediction of corporate profitability falling into the abyss never occurred.  The S&P presently trades at 15x P/E, neither historically cheap nor expensive.  

The bear’s next concern is that companies can only cut so much in fixed costs and that revenue is destined to decline.  Considering only developed economies one would expect this, however costs cut in developed markets are counter-balanced by job growth in developing markets.  

An entrepreneurial middle class has emerged in developing markets with the resultant positive feedback loop between increased demand and job growth.  Although consumption in the developing world is not as established as it is here, it is nonetheless a positive and steeply sloping curve and should more than offset the absence of traditional consumers.  Most economic theory has historically been applied to a (Western) world with an economy of only a billion people.  Today we have a global economy of 4 billion (not including the 2.5 billion living at subsistence level).

The bear argument continues that it is only a matter of time before inflation and interest rates rise aggressively.  Indeed central banks will hike overnight rates sooner than later, however the middle and long end of the yield curve will remain relatively unaffected.  We believe that deflation not inflation is the greater risk. The primary inflation inputs are wages and wage growth which are unlikely to rise given present unemployment and overcapacity.  

The sovereign debt crisis is also being called the catalyst that will lead to the further monetization of debt.  Japan however increased money supply by 85% between 1997 and 2003 without a hint of inflation.  We expect money supply and the velocity of money to continue to drop as private lending remains curtailed and the U.S. consumer remains continues to save.   We further believe that governments will respond by cutting spending, hiking taxes and lowering pension entitlements.  These factors combined should make for a superb disinflationary cocktail.

Where then are equities headed?  The global economy is healing and growing. Corporate balance sheets are well funded and profitability seems to be in place.  With ten year bond rates at around 3.5% we have a compelling reason to believe that the S&P should trade at 17x operating profit.  If we use consensus earnings of $80 for the S&P 500 in 2011 then an S&P 1360 is possible and we could expect to see a further 10-15% increase in equity markets over the next 12 months.

Paul Gardner, CFA, is a partner and portfolio manager at Avenue Investment Management

Johnson & Johnson's slower growth future has already been discounted by investors, leaving shares pretty close to fair value, Glenn Novarro, an analyst at RBC Capital Markets says. 

"We project that JNJ will deliver mid-to high-single-digit EPS growth over the next three years," the analyst told clients in a note Tuesday.

"While this is below the growth rates that JNJ delivered earlier in the past decade, we believe that investors should take comfort in JNJ's ability to cut costs and deliver
consensus expectations.

Trading at roughly 12x forward estimates, Mr. Novarro believes that the stock is already discounting the slower growth estimates and reiterated his 12-month price target of $65.  

On Tuesday, JNJ reported better than expected earnings and revenues for its first quarter, but also cut its earnings guidance to reflect a higher U.S. dollar and healthcare reform.

David Pett

Don't buy any more Telus Corp. shares, says Mahir Yaghi, an analyst at Desjardins Securities. For that matter, maybe stay away from new exposure in the telecom and cable sector all together.

"We are downgrading Telus to Hold as the stock price has performed favourably of late, with its formerly overly depressed valuation now having returned to a more reasonable level," he said.

"While we continue to believe the company will begin to turn the corner in [the second half of 2010], we believe Telus's results will continue to be held back in [the first quarter of 2010] as results are measured against tougher year-over-year comparisons versus later in they year."

Mr. Yaghi also reiterated his Market Weight position for the telecom and cable sector, saying BCE Inc., Bell Aliant, Quebecor Inc. and Manitoba Telecom are also trading at fair value.

His only buy recommendations include Rogers Communications Inc.,  bases on solid wireless positioning and Cogeco Cable, which was recently upgraded on valuation.

David Pett

As Basel regulators and legislators around the world debate banking-sector reform, they have to come to terms with a contradiction. On the one hand, investment bankers and most financial types claim they’re so highly compensated because their business is ultra-competitive. On the other hand, financial industry profits have shot up over the past couple of decades.

This makes no sense: if an industry is highly competitive, its profit margins should be low. Competition eats away at earnings. Look at airlines, or grocery stores, or restaurants, all of which suffer from notoriously low margins. So how can the financial sector be both highly competitive and highly profitable?

Mike Konczai, who writes the marvelous Rortybomb blog, points out that the answer to this question goes a long way to determining what shape financial-sector reform should take. It may also offer clues as to what caused the recent financial crisis.

One possibility, raised by James Crotty of the University of Massachusetts, is that financial sector profits are high, in part, because financial institutions are taking more risks—and perhaps not always being totally transparent about acknowledging them. In a 2007 paper, he asks, “Has the conventional belief that financial investment strategies formerly considered too risky to adopt have been made safe (and profitable) by modern risk-management techniques increased the likelihood of a future systemic financial crisis?” Yes, perhaps so.

Freelance business journalist Ian McGugan blogs for the Financial Post.

Emerging markets will continue to outpace the developed world in 2010, leading to global economic growth of 3.7%, says Nouriel Roubini, the New York University professor also known as Dr. Doom for correctly predicting the 2008 financial crisis. 

In his latest economic outlook, Mr. Roubini said Asian countries excluding Japan will grow 8.2% this year, while Latin America expand at a rate of 4.3%. 

Advanced economies, meanwhile, will grow just 2% in 2010, he said, with the U.S. and Eurozone expanding 2.8% and 0.9%, respectively.

David Pett

Analysts got busy after TD Bank's announcement on Friday that it had bought three small Florida banks, generally giving the deal the thumbs up.

In a note to clients, John Reucassel called it a "solid" transaction consistent with TD's strategy, though he also cautioned that concerns about the loan books of the three banks "are unlikely to disappear" despite the fact that the US regulator has agreed to take a share of any potential losses.

In a statement after markets closed last week, TD said it purchased the assets and liabilities of Riverside National Bank of Florida, First Federal Bank of North Florida and AmericanFirst Bank with a total of 69 branches.

The price of the deal, which was conducted through the US regulator, was not disclosed.

John Aiken, an analyst at Barclays Capital, noted that these sorts of small transactions are exactly what he expects from the major Canadian banks until they have clarity on new capital rules being crafted by global regulators.

"We do not believe that TD or any of the other Canadian banks, will make a significant acquisition until there is much more clarity surrounding the impact of implementing Basel III," Mr. Aiken said.

TD's move now puts pressure on Royal Bank of Canada to follow suit, as Canada's biggest bank has said several times that it is looking to take advantage of opportunities south of the border, raising investor expectations that a transaction is coming, he said.

DBRS said this morning that the Florida transaction has no ratings implications for TD as the price was not material and the impact on capital is minimal.

The rating agency said the deal "will accelerate TD’s growth strategy in the fast-growing market of Florida by adding 69 branches, predominately in central Florida and along the Treasure Coast, that are geographically complementary to TD’s existing Florida banking franchise."

John Greenwood