In this week’s newsletter, we will briefly chat about CPI numbers, release the date for our next members-only Market Mindset episode, and provide an update on Goeasy Ltd, which will translate nicely into some model portfolio changes we have made.
CPI numbers are improving, but they are still poor
Canada’s annual inflation rate came in around 4.3%, still relatively high but also down significantly on a year-over-year basis and right in line with analyst expectations.
Shelter and grocery costs are slowing but still sky-high, at 5.4% and 9.7% year-over-year, respectively. Canadians are taking a hit in mortgage interest costs, as the year-over-year increase of 26.4% was the highest ever recorded.
This will have a ripple effect on the entire economy, which is likely to be felt slowly. As mortgage costs creep up, discretionary spending slows. I’m sure many members are even feeling it at this point. I know I am.
The Bank of Canada’s decision to hold instead of increase policy rates looks to be the right move at this moment in time. However, in our opinion, we will likely see elevated interest rates for longer, as getting inflation under control, particularly food and shelter costs, will not happen overnight.
The Bank of Canada is now faced with the issue of mortgage renewals, as many Canadians who signed cheap pandemic mortgages will be renewing them in the upcoming years or are already feeling the pressure with a variable rate. It is in the best interest of the Bank of Canada to get rates down quicker, primarily due to an awkward situation they created themselves.
However, investors should not bank on the government lowering rates if inflation remains high. If it becomes sticky, we will likely see higher rates for longer.
It is important to keep an eye on rates, but an investment strategy based on where policy rates might go will likely land you in hot water. Even the best economists on the planet cannot predict the direction of policy rates and the broader economy.
As individual retail investors, the best thing we can do is buy strong companies and hold them long-term. Higher rates for longer will ultimately mean more attractive stock prices, a benefit for those with a longer time horizon.
Market Mindset – Analyzing Canada’s banks
We’re set to run a members-only Market Mindset episode this week, where we’ll go over Canada’s “big six” banks, speak on their mortgage exposure, net interest margins, and much more.
The live episode is set to run this Tuesday at 2 PM EST, and a live Q&A for members will follow.
However, please don’t worry if you’re not able to attend. We will make a recording of the episode available for viewing afterwards. As a member, you don’t need to register to attend.
Just keep your eyes open for our e-mail on Monday evening and a final warning on Tuesday, and follow the instructions inside.
An update on Bull List stock Goeasy Ltd (TSE:GSY)
The Canadian government has unexpectedly reduced the maximum allowable interest rate from 47% to 35%. This decrease of 12% is material, no doubt.
In addition, the Government of Canada has stated that it will analyze the situation to determine whether future cuts to the maximum allowable interest rate need to be implemented.
With Goeasy being an alternative lender, its business operations depend on higher APRs (Annual Percentage Rate). As such, the stock has taken a hit in recent times.
Make no mistake about it, these regulatory headwinds are permanent. We cannot see the Government of Canada reverting to the previous maximum allowable rates. Do we feel that the government will reduce this rate even further? No, we don’t. But we do acknowledge that it is a possibility.
Goeasy has stated that only around 36% of its loans were above the newly set maximum threshold, with most coming in at approximately 42.5%.
So, if we go off this information, this event will not change Goeasy’s earnings materially. They still expect strong growth.
But it will no doubt slow the company down. It’s becoming a bit clearer why the company came out with an odd mid-single-digit increase to the dividend earlier in 2023, despite historically raising by 20%+ annually.
It was likely in anticipation that this new regulation would come into play.
Mat has owned Goeasy Ltd for a long time and has zero plans to sell. The company will also remain on the Dividend Bull List, as we feel most of the regulatory hurdles it will face have been priced into the stock.
Not only is it facing these regulatory headwinds, but the possibility of a recession is also adding to default fears in the company’s portfolio, along with lower borrowing activity.
So, there is no doubt that the regulatory changes could not have come at a worse time. However, we also feel that the company will be able to navigate around new regulations and a potential economic downturn and will come out of this just fine.
We’ve made some changes to two of our growth portfolios
Although we’re still bullish on Goeasy, and it will remain on the Dividend Bull List, we will be scaling the positions down in two of our model portfolios, the Early and Mid-Stage Growth Portfolios.
With the proceeds of those reductions, along with profit taking in Constellation Software (CSU) and Well Health (WELL), we’ll be adding positions in our brand new Bull List stock Canadian Pacific Kansas City (TSE:CP). Here is a summary of the transactions:
Early Stage Growth
– We reduced our position in Goeasy Ltd (TSE:GSY) to 2% and our Constellation Software (TSE:CSU) position to 5%.
– We added a position in Canadian Pacific Kansas City (TSE:CP).
Mid Stage Growth
– We trimmed the position in Goeasy Ltd (TSE:GSY) to 2%.
– We trimmed Well Health (TSE:WELL) back to a 2.5% allocation after a significant runup in price.
– We’ve added Canadian Pacific Kansas City (TSE:CP) to the portfolio.
As always, the updated portfolio documents and commentary are available in the model portfolio section of the website here. However, we will discuss the moves below as well.
Portfolio commentary
Regarding Goeasy Ltd, as mentioned company will be allocated downwards inside both these portfolios but remain on the Dividend Bull List. Goeasy had heavy positions in both of these portfolios, in the range of 4-5%.
Although we’re still bullish on the company, we do acknowledge the fact that heightened regulatory risk is real, and we’re going to take a smaller position moving forward.
In the Early-Stage Growth portfolio, Constellation Software had gone above 6.3% in terms of total allocation due to a significant runup in price recently. The stock is overbought now, and we viewed it as a perfect opportunity to sell off some profits and get it back to its target allocation of 5%.
In the Mid-Stage Growth portfolio, Well Health is much the same. Although we’re huge fans of Well Health, we still acknowledge it is a more speculative play at this stage of its business life.
As such, with the position running up to nearly 4% inside the portfolio, we decided to trim it back to 2.5%. There’s still plenty of exposure inside this portfolio if Well Health continues to increase in price. However, there is also the added benefit of booking profits on a 110% runup in price since December of 2022.
The proceeds of all of the sales inside both portfolios have allowed us to take 3%~ positions in a stock we’re relatively bullish on, Canadian Pacific Kansas City (TSE:CP).
As mentioned in our report, we’re big fans of the Kansas City acquisition by CP Rail. The $31B deal significantly expands the company’s network reach and, along with it, accesses new markets.
It is now the country’s only railway that connects Canada, the U.S., and Mexico. It operates nearly 20,000 miles of rail, up from ~12,500 miles previously.
It is a perfect component for these portfolios, as the company does not have a strong dividend growth or yield history and is unlikely to anytime soon as it will likely allocate capital towards debt repayments from the acquisition. However, it is a solid play in terms of total returns and those with a long time horizon.
That’s it for this week, and we’ll see you Tuesday for the Market Mindset Episode.
