John Zechner, chairman and founder, J. Zechner Associates

FOCUS: North American large-cap stocks 

MARKET OUTLOOK:

Stocks rallied this summer as investors believe that the U.S. Federal Reserve can successfully achieve a “soft economic landing.” The economy has shown resilience despite sharply higher interest rates in the past 18 months and second quarter earnings which, despite being down year-over-year, surpassed lowered expectations. Add to this the idea that central banks are basically done raising interest rates and that falling inflation will allow them to start lowering interest rates again next year and we can see why investors have been flocking back to the stock market despite extremely “rich” valuations.

Much of this buying seems to be driven by a fear of missing out (FOMO) mentality as stocks have rallied more than 25 per cent from the October 2022 lows. We are not buying into this bullish narrative and have lightened stock holdings to three-year lows on this strength. While surprised by the resilience of the economy, we attribute this to the accumulated stimulus from both the pandemic and massive infrastructure spending. We have had the easiest money policy on record for most of the past decade at the same time as we have seen massive fiscal stimulus from each of the past two administrations in the U.S. This has all contributed to an extended business cycle despite the sharp increase in interest rates.

However, this highly aggressive increase in interest rates is still expected to dampen economic activity. Additionally, the expiration of pandemic spending programs, along with the rundown of the excess savings that consumers had accumulated during the height of the pandemic, will result in reduced consumer spending and a drag on overall economic growth. Just because this hasn’t happened yet, does not mean it won’t happen at all. Monetary policy traditionally works with “long and variable lags.” In terms of portfolio adjustments we reduced positions in cyclical sectors (autos/metals/semi-conductors), U.S. financials and technology. We maintain overweight positions in energy (on valuation) and telecom (valuation, earnings stability and dividend yield). On top of all the economic, earnings and valuation risks we see, our caution is also heightened by almost all the key investor sentiment measures we look at, which are all far too bullish and very reminiscent of late 2021.

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TOP PICKS:

Rogers Communications (RCI.B TSX) 

Latest purchase $54, August 2023   

All the Telecom stocks have traded down recently over worries about increased wireless competition while Rogers has also been under pressure due to the need to finance and incorporate the acquisition of Shaw Communications. The fundamentals of the company continue to improve with strong wireless results and the bundling of phone, wireless, internet, TV and home security all helping to solidify the customer experience. Streaming also adds to the demand for its services, which have proved resilient in all economic scenarios. The stock trades under seven times forward operating cash flow, generates strong free cash flow and continues to grow.

Pembina Pipeline (PPL TSX)   

Latest purchase $41, August 2023    

We believe that energy infrastructure stocks in Canada present a good long-term growth opportunity as lower-cost oil and gas needs to be moved from the major production fields in Alberta and B.C. to the rest of Canada as well as the U.S. and international markets from the western ports. LNG will also provide a new growth market for Canadian products. Pembina trades at only ten times operating cash flow, is well-financed, has capital growth projects and has a fully-covered dividend yield over six per cent.

BRP (DOO TSX)  

Recent purchase $104,  August 2023   

BRP is engaged in the design, development, manufacturing, distribution and marketing of powersports vehicles and marine products. The stock trades at an exceptionally low valuation of under 10 times forward earnings despite beating estimates in eight quarters over the past three years as it continues to pick up market share from competitors due to stronger product offerings and introductions of new models. Investors worried about an impending economic slowdown have priced the stock for a worst-case scenario. The company is generating strong cash flow, has a good balance sheet and could continue buying its own stock.

PAST PICKS: August 4, 2022

Alphabet (GOOG NASD)

• Then: US$118.87
• Now: US$129.46
• Return: 9%
• Total Return: 9%

General Motors (GM NYSE)

• Then: US$36.23
• Now: US$33.34
• Return: -8%
• Total Return: -7%

Agnico Eagle Mines (AEM TSX)

• Then: $56.28
• Now: $63.19
• Return: 12%
• Total Return: 16%

Total Return Average: 6%