Brendan Caldwell, president and chief executive officer, Caldwell Investment Management

FOCUS: North American large cap stocks  

MARKET OUTLOOK:

Equity markets rallied sharply in the beginning of this year following their dismal performance last year. The Nasdaq Composite Index, dominated by high-growth and valuation-rich stocks, delivered its best January performance since 2001. This was a result of an abrupt shift towards a risk-on sentiment, which was quite contrary to the risk averseness that investors had exhibited last year.

This change in sentiment can be attributed to heightened hopes that inflationary pressures are abating, as the Consumer Price Index (CPI) data published in January demonstrated that inflation declined for the sixth consecutive month in December. Subsequently, investors perceived the federal banks to be adopting a less hawkish stance. This, combined with better-than-feared corporate earnings, fuelled the perceived probability of the economy avoiding a classic recession and instead experiencing the less destructive soft-landing scenario, which would consist of a gradual slide in economic conditions without a severe spike in unemployment or a catastrophic decline in consumer spending.

As a result, the fundamentally weaker areas of the market that posted some of the worst declines last year experienced a sharp turnaround in their stock prices. However, inflation and interest rates remain the determining factors in our view and we believe elevated volatility will remain a key theme this year. If there is a mild recession, earnings may improve later in the year as the pace of inflation slows and 2022’s headwinds flip to tailwinds. If there is a deep recession, it is anyone’s best guess. While we expect higher volatility, times of distress can provide attractive buying opportunities and many solid companies are already trading at significant discounts to recent highs. We continue to focus on identifying high-quality, well-managed companies with proven track records of navigating through tough environments and believe professional investment advice can be extremely valuable in times such as these.

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TOP PICKS: 

Amazon.com (AMZN NASD)

Amazon operates a leading global e-commerce platform, Amazon Web Services (AWS), and Whole Foods grocery stores.

It was one of the major beneficiaries of the pandemic. However, it was inevitable that the tailwinds brought to the company by the pandemic would flip into headwinds as the economy reopened. Consequently, Amazon’s stock that had almost doubled at its peak during the pandemic has now come back down to its pre-pandemic valuations as the economy has reopened.

Amazon has been seeing a notable pullback in discretionary categories, similar to other retailers, which has been affecting the sales and margins in its retail business.

AWS segment grew 20 per cent year-over-year and was the sole contributor to the company’s overall operating income in the recent quarter. However, this seemingly enviable growth was a deceleration from AWS’s recent growth rates as enterprises cut costs to optimize their spending by opting for lower cost providers instead. Management expects these cost optimization headwinds to persist for the following few quarters. However, in the longer term AWS is set to benefit from secular tailwinds of corporate workloads migrating to the cloud.

Advertising grew 19 per cent year-over-year in the recent quarter, despite the downward industry trends with competitors seeing their ad revenues decline due to sellers becoming frugal in their marketing budgets.

It continues to gain share of global e-commerce, which is also a growing pie as the secular shift to e-commerce is expected to sustain.

At the current valuations, which are more in-line with their pre-pandemic levels, in addition to the headwinds faced by the company having been well priced in, AMZN currently offers a decent value proposition for the longer term.

ANSYS (ANSS NASD)

ANSYS is a developer of engineering simulation software and also provides software services for a wide range of industrial and systems applications. It reduces the need for costly and time-consuming physical prototyping, allowing engineers to develop more effectively.

As a market leader, it is set to capitalize on the “digital everything” trend that has only been propelled by the design complexities that have been induced by the pandemic. It has meaningful exposure to high-growth end markets of electric vehicles and 5G etc.

It is benefitting from continued strength in aerospace and defence due to the heightened geopolitical tensions.

ANSYS is transitioning towards a subscription model, as subscription licenses gained momentum in the latest quarters versus perpetual licenses. This may result in lower revenue growth in the near term as the company gives up large upfront perpetual license fees for smaller but repeating revenues. Over the longer term it typically improves renewal rates, provides increased revenue stability, and greater pricing controls.

Although competition has been intensifying in the computer-aided design (CAD) market, ANSYS is a dominant player that should continue capturing share, as evident by the company seeing its backlog increase in the fourth quarter by 13 per cent year-over-year.

Comfort Systems USA (FIX NYSE)

FIX installs comprehensive heating, ventilation, and air conditioning as well as providing maintenance, repairs, and replacement services.

The company has a solid backlog that is up ~75 per cent year-over-year, which was a result of the backlog growth accelerating.

Management sees potential for the backlog to continue growing modestly in 2023 as it is experiencing a strong bidding environment overall.

The company is essentially booked for 2023 and is now taking orders for 2024.

FIX has been facing gross margin headwinds due to input cost inflation, however, inflation possibly declining going forward will provide a modest tailwind.

The company has been benefitting from reshoring activities recently and its management expects the reshoring process to become a larger growth driver going forward.

PAST PICKS: March 30, 2022

CME Group (CME NASD)

• Then: $241.80
• Now: $184.74
• Return: -24%
• Total Return: -20%

Quanta Services (PWR NYSE)

• Then: $132.16
• Now: $162.28
• Return: 23%
• Total Return: 23%

Micron Technology (MU NASD)

• Then: $79.16
• Now: $57.68
• Return: -27%
• Total Return: -27%

Total Return Average: -8%