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Why investment risk is everywhere, a stock that's a licence to print money, and the odd path of the loonie

A Canadian dollar coin. The loonie hit a two-month high after the Bank of Canada said the central bank would assess if it needs to keep rates at near-record lows as the economy grows.


"It's not a surprise that the biggest risks to Canadian wealth involve issues no one wants to read about. There is a certain kind of tunnel-mindedness required for risks to grow dangerous in the first place.

I'm not talking about the domestic housing market either – recent media coverage has been entirely focused on the potential for calamity and we're talking about areas where risk is underappreciated.

I mentioned previously that when writing columns about China, Report on Business readers avoided them like it's their job. It remains the case though that Chinese demand for resources drives global commodity prices, and the country's ongoing efforts to reform lending practices are a major force behind the recent carnage in industrial metal prices, and many Canadian mining stocks.

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We joke in the newsroom that the most certain way to ensure no one reads our work is to put either 'Europe' or "Federal Reserve" in the headline. In the latter case,  Chairwoman Janet Yellen's announcement of a rate hike Wednesday, along with the stubbornly hawkish statement that came with it, is a reminder that the free money, ultra-low interest rate environment is being withdrawn.

For strategists like Citi's Matt King, who believe the value of equities and real estate have been appreciating in accordance with the size of central bank balance sheets, monetary tightening is a very big deal. If assets went up with expanding balance sheets, they are likely to fall as central bank asset purchases decline. In a report released Friday, Mr. King writes, "The Fed's planned balance sheet reduction, coupled with ECB tapering, seems likely to destabilize markets sufficiently that we think they will be unable to complete it."

The area with all the sentiment-related hallmarks of a bubble is income and dividends. Global investors are happily scooping up long dated bonds with meagre yields despite the added risk relative to shorter term issues. Junk bonds offer yields close to government debt, again ignoring the extra risk.

Domestically, corporate debt relative to earnings is steadily rising, endangering dividend yields in some cases. Stronger economic data also has economists predicting Bank of Canada rate increases in 2018, which will negatively affect all income-providing investments. Above all, record household debt levels strongly imply the end of the credit cycle is drawing near, and the subsequent, necessary deleveraging process will limit returns for all credit-sensitive investments.

Thankfully, recent market action shows declining odds of sharply higher interest rates and bond yields in the short term. Weak commodity prices suggest slower growth and inflation ahead and global bond yields are generally heading lower.

It's a difficult balance to maintain, but investors should look everywhere for potential risk, particularly with popular investment themes, but not panicking when they find it. It's the problems we don't see coming that cause the most portfolio damage.

--Scott Barlow

This is the twice a week Globe Investor newsletter. If someone has forwarded this e-mail newsletter to you, you can sign up for Globe Investor and all Globe newsletters here.

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Stocks to ponder

SNC-Lavalin Group Inc
. This is a stock that has been an underperformer but according to analysts, the share price is expected to make a comeback. The Street is anticipating the stock will deliver a price return of 25 per cent over the next year, and the stock has 10 buy recommendations, writes Jennifer Dowty. Montreal-based SNC-Lavalin is an engineering and construction company servicing clients across four market segments: oil and gas, mining and metallurgy, infrastructure and construction, and power.

Russel Metals Inc. This stock is two per cent away from appearing on the negative breakouts list as its share price steadily drifts lower, writes Jennifer Dowty. It is one to closely watch as falling oil prices could continue to dampen investor sentiment for this stock given its exposure to the oil patch through its energy products segment. Lower and unstable energy prices can negatively impact demand from its energy product customers due to potential lower rig count and drilling activities. For that reason, the current downtrend in the stock price may continue, creating a future buying opportunity. The stock offers investors an attractive 6 per cent yield. Analysts on the Street are bullish on the stock anticipating a 25 per cent price return over the next year (over 30 per cent total return if you include the dividend). The stock has a unanimous buy recommendation.

ABB Group. This is a Swedish-Swiss company based in Zurich that trades as an American depositary receipt as ABB Ltd. on the New York Stock Exchange, writes Gordon Pape. ABB can trace its history back to the late 19th century and employs 132,000 people worldwide. The company is a world leader in robotics, industrial automation, clean energy and software development. It is the world's largest builder of electricity grids, a leading maker of electric-car infrastructure and a manufacturer of solar-power equipment. It recently reported a 45-per-cent increase in net income and it continues to expand with acquisitions.

Swiss National Bank. When investors say a company has a licence to print money, they usually mean it is very profitable. But in the case of Swiss National Bank, there is an actual licence to print money. Could this be why SNBN's shares were up 70 per cent over the past 12 months? And will the company continue to be a good investment? Yes, SNBN really does have a printing press. As the central bank of Switzerland (official name: Schweizerische Nationalbank), it has a legal monopoly on creating Swiss francs. And it has shares trading on an exchange because the bank was founded in 1907 as a joint-stock company to give it independence from government. Larry MacDonald explains.

The Rundown

Could strong economic growth shake bank stocks out of their torpor?

Canadian bank stocks continue to grind sideways, raising the question of what might inspire the next rally. Could the improved outlook for the Canadian economy do the trick? Recent share price performance has certainly been lacklustre, writes David Berman. The S&P/TSX commercial banks index, which includes all the Big Six along with Canadian Western Bank and Laurentian Bank of Canada, has slumped 7.5 per cent from its highs in March and is now down for the year. The recent second-quarter reporting season, when most banks beat analysts' estimates and three banks raised their quarterly dividends, failed to ignite any enthusiasm – for three reasons.

There's something weird about the loonie's latest climb

Two weeks ago the loonie looked hugely overvalued relative to bond yields and undervalued relative to oil prices. These divergences have now been largely corrected, but the weird part is that these two primary drivers of the currency are lagging the Canadian dollar's traded value: In normal circumstances, bond yields and oil move first and the loonie follows, yet now it appears the order has been reversed, writes Scott Barlow. Relative bond yields and oil prices are the two most powerful forces determining changes in the loonie's price. In different ways, both indicate changes in money flows into the country. A higher oil price means more American dollars sold and exchanged into Canadian currency to purchase our oil. Higher domestic bond yields relative to U.S. yields means more foreign investors buying Canadian bonds to take advantage of rising dividend income. He explains using two charts.

A deeper dive into my Strategy Lab dividend portfolio

Strategy Lab is approaching its fifth birthday in September, and over the years John Heinzl says he's received plenty of comments and questions about his model dividend portfolio. He says that's great. It shows people are interested in managing their own money and learning more about dividend investing. He answers some of the most common questions from readers.

Worried about rising interest rates? Here's an idea that's gaining traction

The Bank of Canada is mulling its first interest-rate hike in seven years, and an unlikely winner in this dramatic shift in monetary policy has emerged: preferred shares, writes David Berman. The S&P/TSX preferred share index marked its biggest one-day gain of the year, rising nearly 1.2 per cent on Tuesday. The move in what is typically a sleepy corner of the market comes a day after the Bank of Canada's senior deputy governor Carolyn Wilkins hinted that broad economic growth could lead to higher interest rates. David Berman explains.

Health care stocks loom large in StarMine analyst awards

Even by the standards of the health-care sector, last year was an unsteady one.In a segment of the market rife with risk under normal circumstances, the two biggest stocks in Canadian pharmaceuticals broke down over concerns about debt and unsustainable business models. But the same sector that produced all that volatility also produced the two top-performing analysts on Bay Street for 2016. Tim Shufelt looks at two top analysts as chosen by Thomson Reuters StarMine Analyst Awards.

A quick guide to understanding your investment returns

The investing world thrives on intimidating everyday people, writes Rob Carrick. To maintain its mystique, the industry too often uses jargon instead of plain language (equities, not stocks; volatility, instead of the risk of losing money). And numbers as basic as those used in published investment returns are often left vague. Are we looking at total or nominal returns? Net returns, or gross? Here's an investment return cheat sheet to help you make sense of your own results, and those of the funds you own.

ETF rebalancing a bumpy ride for junior gold miners

In an unprecedented move, one of the most popular junior gold miner exchange-traded funds is set to rebalance on Friday after growing too large for its market. After months of volatility, miners and investors alike are preparing for even more uncertainty, writes Joyita Sengupta. Cursed by its own success as a $4-billion (U.S.) ETF in a $30-billion space, VanEck Vectors Junior Gold Miners ETF (GDXJ-N) began to expand beyond the index it tracks, the MVIS Global Junior Gold Miner's Index. Combined with VanEck's Vectors Gold Miner ETF, (GDX-N), the company is nearing the significant shareholder status point of 20-per-cent ownership in several companies, many of which are Canadian, which means special filing requirements and significant trading restraints.

The great Active Share smackdown (or how to spot closet index funds)

Ten years ago, finance professors Martijn Cremers and Antti Petajisto introduced Active Share as a tool to help investors decide if they are getting value for their investment management fees. Simply stated, Active Share measures the difference in the holdings of a portfolio, both in terms of the names and the weights, compared to the portfolio benchmark index. A bottom-up stock picker's portfolio, for example, would have a very high Active Share approaching 100 per cent, whereas an index fund which is designed to mimic the index would report an Active Share of 0 per cent. Robert Tattersall explains more.


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Ask Globe Investor

How should I invest in the resources and commodities sector? Should I invest in an ETF or a small basket of ETFs that helps allocate my funds appropriately within the sector or should I choose individual companies? If I am choosing individual companies, which groups within the sector do I choose? One oil and gas, one gold, one copper, one lithium, for example? I wouldn't know where to begin. If the former is the way to go for me, do you recommend any ETFs or mutual funds that satisfy my goals?

Answer:  We have several stocks on my newsletter recommended list that would provide exposure to a range of resource sectors. For precious metals, I like Franco-Nevada Corp. (FNV-T), which has performed very well. For copper, look at Lundin Mining Corp. (LUN-T). Teck Resources Ltd. (TECK.B-T) is Canada's largest diversified resource company, with mining operations focused on copper, steelmaking coal, and zinc. As well, it has energy interests in the Foot Hills Oil Sands project, which is scheduled to come into production next year.

If you prefer an ETF, the iShares S&P/TSX Capped Materials Index ETF (XMA-T) provides exposure to all types of resource stocks except oil. Top holdings include Barrick Gold, Potash Corp., Agrium, and Franco-Nevada. However, over half the portfolio is in the gold sector and returns have not been great, averaging less than 1 per cent annually over the three years to April 30.

There are many natural resource mutual funds that include energy stocks in their portfolios along with mining and other resource companies. However, most have unimpressive track records – some have lost more than 20 per cent annually over the past three years.

One that's worth a look is Scotia Resource, which has a three-year average annual return of 2.8 per cent and a one-year gain of 8.1 per cent. It is a no-load fund that invests internationally. Some of the top positions are in NexGen Energy, Lundin Mining, Agnico-Eagle Mines, and TransCanada Corp.

My own preference would be to focus on the individual stocks I have mentioned

-- Gordon Pape

Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.

What's up in the days ahead

Rob Carrick examines perpetual preferred shares, Tim Shufelt looks at the TSX's dismal performance this year, and Brenda Bouw looks at what Jim Schetakis, senior vice-president and portfolio manager at Barometer Capital Management, is buying and selling.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Gillian Livingston

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