Slowing Growth, Higher Returns?

Another institution has cut its growth outlook for the Asia Pacific basin. In this case the World Bank which believes that China may be headed for a protracted period of slower growth. Although one should put that into perspective as 7% per annum GDP growth is considered slow for China.

The concern is that China is feeling the pinch of slowing demand from the eurozone, its largest trading partner. Because analysts have been telegraphing this message for some time it is not surprising that the markets reaction was muted. But should investors get spooked by further downbeat guidance throughout the upcoming third quarter earnings season the mood could change quickly.

The fact is there are simply too many uncertainties for most investors to make long-term commitments. Take the earnings outlook as an example. Many analysts have been taking down their numbers for the third quarter, which should be a negative. But you could look at the reduced expectations as a positive because it sets the stage for bigger than expected upside surprises.

Also in the mix is the fact that companies have some of the strongest balance sheets on record. And that will continue until North American executives get clarity around government policies and consumer attitudes.

On a macro level central banks are providing ample liquidity and will continue to engage in this strategy for a protracted period of time. Never has the term “don’t-fight-the-Fed” played such an aggressive role in the investment landscape.

One could argue that such aggressive policies are will lend support to the market effectively limiting downside risk. Certainly central banks largesse forces investors to apply “risk-on” strategies as there are fewer places to put money to work. Stocks are simply the best of a bad situation.

To that end, I think investors should focus on the Canadian financial sector. US banks have delivered twice the return of Canadian banks throughout 2012. And while it is fair to say that US banks were recovering from a very deep hole, there is a case to be made that Canadian
banks have lagged and could turn in some very strong numbers over the next twelve months.

The one thing that impressed me about 2012 was the number of dividend increases announced by Canadian banks. Toronto Dominion (TD, Friday’s close $82.05) not only announced a dividend increase but also decided to increase the dividend payout rate. The payout rate is the percentage of a company’s earnings that the Board has approved to be paid out as a dividend. Typically companies up their dividend payout when the Board is comfortable about the trend in earnings and the sustainability of that trend.