Brendan Caldwell, president and CEO at Caldwell Investment Management

MARKET OUTLOOK:

The market has done quite well so far this year, maintaining its strong momentum from last year despite the elevated economic and geopolitical uncertainty. The bullishness primarily stemmed from an increased perception that the U.S. Federal Reserve had been able to suppress inflation, to a large extent, without causing a full-blown recession, and therefore could start cutting interest rates. The strength of the labour markets, coupled with the continued gross domestic product (GDP) growth, also provided further support to the market’s confidence, helping alleviate the fear of recession. However, the expected rate cuts have not materialized as the central banks in Canada and the U.S. have kept rates unchanged since July last year, contrary to the multiple cuts that had been anticipated.

While the Fed has now indicated that a rate hike would be unlikely, it is also not rushing to cut rates as inflation is proving to be more resilient than expected. The market now seems to be pricing in a slightly weakened sentiment as evidenced by the recent pullback, which may persist as we progress through the year if earnings expectations are not met going forward, and if inflation and the interest rates do not move in the desired direction. This prompts us to maintain our focus on identifying high-quality, well-managed companies with proven track records of navigating through tough environments. Hence, we believe that professional investment advice can be extremely valuable in times such as these.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

TOP PICKS:

Ares Management (ARES NYSE)

What it does?

Ares Management is an alternative asset manager with around $380 billion in assets under management (AUM), primarily focused on private credit. Revenues primarily derived from management fees (around 80-85 per cent) which have grown consistently through market cycles (no negative growth in management fees since 2006). Long-lived, locked-up capital.

Why do we like it?

Industry consolidation among leading alternative asset managers given better resource pools and return track records. Private credit benefits from a rising rate environment (deals are floating rate) and is more agile than banks in deploying capital in a low transaction environment (should see a rebound in deployment in the second half of 2023).

Institutional allocations to PE are above target vs. under-allocated to PC - ARES seeing traction here as follow on fund sizes exceed prior vintages by 30-40 per cent plus. Over time, simplification of bank business models/de-risking and simpler bank balance sheets will provide opportunities for private credit to gain share (exacerbated by the 2023 banking crisis). Targeting 45 per cent FRE margin by end of full year25; moving through a period of strong hiring, now expecting margins to expand as they move into the capital deployment phase. About 70 per cent of earnings from management fees versus 55 per cent for peers (these are more predictable than performance fees and in ARES' case, have grown consistently through economic cycles).

CME Group (CME NASD)

What it does?

A leading derivatives exchange operator with offerings across equity indices, fixed income/rates, commodities, energy, agricultural, metals, foreign exchange and cryptocurrencies. Has exclusive licenses with S&P 500 Index, MSCI World, Nasdaq Index and FTSE Russell to be the sole platform for trading its index futures and options on futures.

Why we like it?

Strong uptake of miniaturized contract sizes driving sustained trading volume. Defensible pricing power in the core transaction and clearing business. Depending on the asset class, CME has the world’s deepest liquidity pools which lead to tight bid-ask spreads.

As a result, despite less customization than OTC derivatives, traders/speculators will get better execution and lower total cost to trade on CME. Proprietary licenses also mean CME is the only venue in town to gain access to certain derivatives.

CME sits on a wealth of proprietary transaction data across asset classes which is valuable for helping traders/speculators make decisions. Given its proprietary nature, CME’s pricing power within its data business is actually stronger than its transaction and clearing business. Transitioning that data to the cloud allows for quick creation, testing and client feedback of new data and analytic products. Over time, the sales team has been better incentivized to go out and sell data products to new and existing customers, helping accelerate growth.

Rising living standards in developing countries have driven the proliferation of trading and investing. International markets are underpenetrated relative to North American markets; similar to its data business, CME has benefited from a more target focus on selling into international accounts.

WW Grainger (GWW NYSE)

What does it do?

Distributor of maintenance, repair and operating (MRO) products and services in North America (NA), Japan and the U.K. Serves 4.5 million customers globally (no customer accounted for more than three per cent of sales). High-touch solutions serve customers with larger, more complex buying needs primarily in NA. Endless Assortment is an e-commerce portal offering millions of products same day or next day, primarily to smaller customers.

Why we like them?

Primarily an organic growth story that has leveraged its scale and technology investments to take market share. Vendor consolidation among scale players should drive continued market share gains for GWW given a broader product assortment, user-friendly online interface and fast shipping capabilities.

Re-merchandising/simplifying the online product search and ordering process has driven strong revenue lift; we expect this can drive wallet and market share gains over time as customers can more easily find what they need in one place. Better use of data and tech also allow for more robust pricing strategies, supporting gross margins. GWW has seen additional margin uplift from recovering supply chains post-COVID-19; they believe smaller peers are not recovering as quickly. 

PAST PICKS: MAY 12, 2023

TJX Companies (TJX NYSE)

• Then: US$78.99
• Now: US$96.57
• Return: 22%
• Total Return: 24%

Stryker (SYK NYSE)

• Then: US$285.47
• Now: US$325.11
• Return: 14%
• Total Return: 15%

Granite REIT (GRT.UN TSX)

• Then: $81.31
• Now: $69.89
• Return: -14%
• Total Return: -10%

Total Return Average: 10%