Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities

MARKET OUTLOOK:

Many of today’s investors have likely long forgotten the 1999-2010 era, a period in which Canadian stocks outperformed U.S. stocks in 10 of 12 years. Remarkably, Canadian stocks have lagged their U.S. counterparts in ten of the last eleven years since then. Two major forces converged this past quarter to benefit Canadian stocks relative to U.S. stocks – interest rates and commodity prices. Bond markets and interest rate derivatives markets are now pricing in over 200 basis points of rate hikes in 2022 in both the U.S. and in Canada. Given the heavy concentration and weighting of growth stocks in the major U.S. indices, and given the relative dearth of them in Canada, higher interest rates create a greater headwind for the U.S. indices relative to Canadian ones. This is because growth stocks are more interest rate sensitive than value stocks.

Moving to commodities -- a classic inflation hedge -- which had been enjoying a strong, albeit not sensational bull run since April 2020, the tragic and appalling outbreak of war in Ukraine this quarter sent this commodity bull market into overdrive, with huge rallies in oil, natural gas, gold, nickel, fertilizers, corn, wheat, soybeans and more. Significant Russian supply of many of these commodities fell swiftly (and quite rightly) under economic sanction by virtually all Western governments, tightening already tight markets. Canadian companies have an important role to play in ensuring security of supply in many of these commodities and stand to benefit from markedly higher commodity pricing.

With the heavy concentration of commodity producers in the S&P/TSX Composite index (30 per cent vs. seven per cent for the S&P 500), these commodity price effects have had a meaningful impact on overall index returns. Conversely, 80 per cent of the decline in the S&P 500 index in Q1 was attributable to weakness in the technology and communications sectors – a concentration risk that we actively and significantly mitigated by selling the FAANG stocks down to almost zero weights.

Our portfolio positioning currently favours defensives over non-resource cyclicals, favours value over growth and favours Canada over the U.S. All the while, we strive to manage the known unknowns by owning thematically neutral portfolios, comprised of, both “work from home” beneficiaries and “reopening” trades to avoid making binary bets on the next phase of the pandemic saga. 

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TOP PICKS:

Agnico Eagle Mines (AEM TSX)

• Latest purchase Mar 2022 @ $76.50

Agnico-Eagle is Canada’s second largest gold miner, having recently completed a transformational merger of equals with Kirkland Lake Gold. The shares are almost a pure play on gold, unlike some of the other polymetallic producers, with 2022 planned production of 3.2m ounces comprised 98 per cent of gold and two per cent silver.

The company has paid a dividend every year since 1983 and in February increased their dividend by 14 per cent, such that the shares now yield 2.5 per cent, which is the second highest yield in the mid-to-senior gold miners group and is well above the ten year average dividend yield of 1.5 per cent that the shares have historically offered.

With 12 producing mines in Canada, Finland, Mexico and Australia, single mine concentration risk is low, and political risk is negligible in these mining friendly jurisdictions. The company has a well-deserved reputation among investors for credibility and execution against strategy, as their history of exceeding production guidance in nine of the last nine years and their record of exceeding consensus earnings forecasts in 14 of the last 15 quarters demonstrates.

CVS Health (CVS NYSE)

• Latest purchase Apr 2022 at $103.86

CVS is best known as America’s leading pharmacy, but two transformational acquisitions over the last fifteen years has morphed it into a vertically integrated health care colossus, occupying position #4 on the Fortune 500, with $300 billion of revenue spread across an upstream health care benefits/health insurance business, a midstream pharmacy benefits management business and the downstream retail network of stores.

The company has grown earnings at a compound rate of nine per cent over a decade, and the move upstream into the PBM and managed care business accelerates their growth and profitability into a huge addressable market – Americans spend $3.8 trillion annually on healthcare, broadly defined. 

The shares yield 2.2 per cent and trade at an undemanding 12x forecast earnings vs. the 20 year average of 14x and the company has earmarked $10B to buy back shares this year. Prior bull market cycles in this stock are big and long, averaging 438 per cent in price appreciation over a 6.25 year time frame, suggesting the bull run in these shares is barely halfway complete off the 2019 lows.

Quebecor (QBR.B TSX)

• Latest purchase May 2022 at $29.60

Quebecor is primarily a telecom and media company with a small sports and entertainment segment. The telecom biz is their bread and butter, comprising internet, wireline and wireless services. This unit has a 21 per cent market share in Quebec but is outgrowing the national players consistently in the crucial wireless service line of business. 

The media biz is carried out primarily through their 65 per cent voting stake in TVA Group, which is the dominant conventional and specialty TV broadcaster in Quebec, with a market share that exceeds all other players combined, plus some newspapers and magazines, outdoor advertising and digital ad-supported media. 

With a 4.1 per cent yield and a dividend that is expected to grow nine per cent this year, we see a good path to a stable double digit total return with very little cyclicality. An additional catalyst is the pending closing of the all cash Rogers/Shaw merger which will likely leave telecom investors looking for reinvestment options, and which could also see the Freedom Mobile wireless spectrum fall into Quebecor’s eager hands.

Curaleaf Holdings (CURA CSE)

• Then: $18.24
• Now: $7.49
• Return: -59%
• Total Return: -59%

Laurentian Bank (LB TSX)

• Then: $42.70
• Now: $39.15
• Return: -8%
• Total Return: -5%

Methanex (MX TSX)

• Then: $47.48
• Now: $69.05
• Return: 45%
• Total Return: 47%

Total Return Average: -6%