Michael O’Brien, Managing Director and Portfolio Manager, TD Asset Management discusses sectors to watch in 2019 with Kim Parlee, particularly in the energy, banking and railway space.
I want to talk about volatility. I mean, I said at the open that we've had-- I think, we've only had, I think, these 600, 700 point drops eight times in history, and five happened last year. That's crazy. I mean, is that something-- it seems to have leveled out for a few days, but are we-- should we go in and expect more of this?
Unfortunately, the answer is yes. I think it's going to be a bumpy year volatility-wise.
I think we're going to have a lot of false starts. We're going to have some days where you feel pretty good about things. And then, there'll be some setbacks along the way. And, again, I think a lot of that emanates from just the unpredictability of the US president and his ability to turn on a dime. That's going to buffet the markets through the course of the year.
It doesn't mean it's going to end badly. It just means if you're expecting a nice smooth ride like we had for the last couple of years, before 2018, I think this isn't going to be the year you get that.
Yeah. The one thing, of course, that's-- we've seen a lot of the tech sell-off, which has really hurt the US markets. But oil has had an incredible fall and an incredible recovery in the past little while as well. Take us through a bit what's happened there, and why we've seen-- we were just chatting in the break-- I think that oil has gone from-- what was at it at the lowest? I think it was at 13 or--
Well, yes, Western Canadian Select-- so the heavy Canadian oil was as low as $13 a barrel in mid-November--
--and it's up to $43 a barrel today.
So it's almost quadrupled?
Yep. In the span of two months.
So take us through the factors and why it's gotten there.
Yeah, so, obviously, the way we got into this mess in the first place was we had to work very hard at this as a nation for many years, was the inability to get a proper pipeline egress for the Western Canadian sedimentary basin. Put another way, we haven't been able to build pipelines.
And so a lot of these companies invested billions of dollars on the assumption that, by the time these big projects began flowing oil, they'd be able to get it to market. We found out that wasn't the case last year. So that's the root of the problem is not enough ways to get oil out of Canada. It became a huge issue, obviously, in the fall. It got so bad that Western Canadian Select-- so in other words, producers in Alberta were selling their barrel of oil for $50 less than everybody else in the world.
Ridiculous. Desperate times call for desperate measures. And so a number of short-term fixes have been put in place now, one of which is increased crude by rail. That took a little while to get going, but it's really kicking in now. By October, they were railing 327,000 barrels a day.
Really nice improvement. A second thing, obviously, the province of Alberta stepped in and mandated that producers cut production by 325,000 barrels a day for the next three months at least. I think that's had another big impact. And I think just this pressure to resolve the issue has flushed a lot of speculators or manipulators out of these markets as well. And so what you've seen is just an incredible improvement in a very short period of time, where, like I said, at the worst, in mid-November, differentials were $50 a barrel. Today, they're under $10. They're $8.50 a barrel.
And has that swung too far in the other direction?
Yeah, we shouldn't anticipate that the differentials are going to stay at these current levels. I would expect somewhere in the $15 to $20 a barrel range for the year would be just fine. That's the short-term solution. This is a bridge. Things like crude by rail, these are bridges. What we really need is more permanent solutions. So the first step with that would be Enbridge's line 3 pipeline, which is supposed to come into service this fall before the end of the year.
You grab a drink of water. Let me ask you a long question. I know that-- one of the more interesting things, too, that I heard from the Bank of Canada governor was talking a bit about the surprise you could see on business investment in the oil sector, in the energy sector because he's implying-- and I'm paraphrasing here-- you could see surprises to the downside, but you could also see surprises to the upside-- I mean, based on lowered expectations, essentially, and where oil is going right now. Is that something to watch?
Oh, absolutely. I mean, it's obvious the problems that we face. But if you want to think a year or two forward-- so right now, we've got a 370,000 barrel a day pipeline that should be in service before the end of this calendar year. And don't forget that Keystone XL, this project that's been on again off again for over a decade, TransCanada is hoping to start breaking ground in June on this project. So as desperate as things seemed three to six months ago, we could be sitting here a year from now with, basically, the pipeline egress issue solved. So that's the two-sided nature of the coin, I think, that the Bank of Canada is referring to.
Right. It's binary, though. That's the one thing. It goes one way or the other. Let me ask you-- we've got about 2 and 1/2 minutes here. But when you look at sectors, Canadian sectors in 2019, what's looking attractive? I mean, people had the foresight, which I'm going to bet you probably did, to look at oils back when we saw Western Canadian Select at around $13. I'm sure that would have been one. But now, what are you looking at?
Well, to your point, going back to the beginning of the conversation, I'm not in the camp that this is-- we're going straight down into a big global recession. I don't think this is analogous to 2007, 2008. And so from that perspective, my personal view is, the big market declines we saw in the fourth quarter of last year weren't necessarily grounded in fundamentals-- that I think sentiment and fear got the best of us. And what it means is companies in the more cyclical or more economically exposed parts of the market actually look very attractive now. So you don't have to dig too deep. If you look at the big banks, like Royal Bank and Bank of Nova Scotia, they look extremely attractive at these prices. Again, in the--
Even without interest rates increases coming?
Even without interest rates increases coming. Unless we get a real big downturn and the credit cycle turns hard, I think they look pretty solid. Same thing in the oil patch. I don't think it's-- by no means is it too late to take a look at a name like Suncor or Canadian Natural Resources. You look at the CP Rail has been benefiting from the crude by rail situation.
Is CP benefiting more than, say, CN?
CN and CP are both-- they're both doing quite nicely. And both of those companies are performing very well. They've got nice pricing power right now. So again, after the big market setback we had in Q4, the valuations kind of reset to levels that looked much more interesting today.
So those are where I'm finding the most interesting ideas. At the same time, I always want to have a bit of a defensive bulwark in the portfolio. So in that area, we still find some interesting opportunities in the staples, even though they have recovered a bit-- so names like Couche-Tard to me look pretty attractive.
Let me ask you to play devil's advocate for your own-- I mean, just for a little balance. I only have about 30 seconds. But you mentioned with the banks, the cycle turns, not so good. What about energy and rails? What would happen there to make those not as attractive? Same?
Cycle turns. It's really that simple. I think if you're in the camp that we're going to get hit hard, we're going to have a big economic downturn, then earnings are at risk in big parts of the market. I would say the banks probably hold up reasonably well relative, but everybody's going to take a bit of a shot.
Michael, always a pleasure. Thanks so much.