Chris Blumas, portfolio manager, Raymond James Investment Counsel Ltd.
FOCUS: North American large cap stocks

MARKET OUTLOOK:

All eyes are on the U.S. Federal Reserve as it tries to combat high inflation and engineer a soft landing for the U.S. economy. Inflation pressures were expected to moderate this year but Russia’s aggression in the Ukraine and the prospect of further lockdowns in China have created additional supply chain pressures that could be more enduring in nature.

While high energy prices, rising interest rates, and lower government aid will undoubtedly hinder future economic growth, consumer spending is likely to remain strong over the near term. Consumer spending is the largest component of US GDP (~70 per cent in 2021) and is being fueled by robust household savings, low unemployment levels, and rising wages.

Against this economic backdrop, the Federal Reserve has started an abrupt monetary policy “U-turn” by reversing course and initiating plans to shrink its balance sheet and increase interest rates. With the ratio of wealth-to-income at an all-time high (~25 per cent above its prior peak) and aggregate credit growth expected to remain weak, the more speculative pockets of the financial markets could be vulnerable to a correction as liquidity is removed from the financial system.

With low nominal interest rates and negative real returns, investors holding cash and low yielding fixed income securities risk a loss in purchasing power over time. While putting investment dollars to work in this uncertain environment can be challenging, equities still look like an attractive asset class for investors. Going forward, I think investors should remain well diversified and defensively positioned. Some areas of the equity market that look to offer attractive value include select technology companies, diversified REITs, and financial services companies.

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TOP PICKS:

Brookfield Asset Management (BAM.A TSX)

Most recent purchase at $73.10 on 2022-04-05

Brookfield is a direct investor and third-party asset management firm with a unique focus on real assets and private equity. The company is one of a handful of global private equity players that are uniquely positioned to raise large amounts of capital from institutional clients as they shift their portfolios towards higher yielding asset classes. While the company has three publicly listed operating subsidiaries, these securities don’t provide investors with exposure to the rapidly growing asset management business. Over the last 12 months, total assets under management have increased by 17 per cent to US$365 billion while distributable earnings before realizations have increased by 23 per cent. The shares currently trade at 12X trailing funds from operations and have a core free cash flow yield of almost 4 per cent.

Walt Disney (DIS NYSE)

Most recent purchase at $135.55 on 2022-04-05

Disney is a global media and entertainment company that generates revenues by distributing original content, providing customer experiences at its parks and resorts, and by selling consumer products. Disney shares are down by almost 30 per cent over the past year as structural streaming concerns have negatively affected investor sentiment. During its most recent quarter, Disney+ subscribers hit 130 million (up 37 per cent year-over-year) and the revenue from its parks, experiences, and products segment reached an all-time high as visitors returned to its attractions and per capita spending exploded (up 40 per cent year-over-year). Going forward, it’s going to take Disney some time to return to its pre-pandemic level of profitability, but its unique assets and digital capabilities enhance its competitive position and create a platform that should help to drive future EPS growth. The shares currently trade at a 20 per cent discount to a conservative sum-of-the-parts valuation of $162 per share.

Alphabet (GOOGL NASD)

Most recent purchase at $2,794.26 on 2022-04-01

Alphabet is an investment holding company. The company’s main asset is Google which accounts for 99 per cent of Alphabet’s revenue. Google generates more than 80 per cent of its revenues from online ads and generates the remainder from the sale of apps, content, and cloud services. As advertising dollars continue to move online, Google is uniquely positioned to continue growing revenues and cash flow. Last year, the company’s revenues and free cash flow were up 41 per cent and 56 per cent respectively over the prior year. On the negative side, Google continues to face greater regulatory pressure to safeguard user privacy and to lessen its online dominance. The shares currently trade at almost 23X forward earnings. However, this valuation doesn’t account for the excess cash on the company’s balance sheet ($125 billion or $185 per share) or the hidden value associated with its cloud services business or its early-stage technology investments.

PAST PICKS: June 8, 2021

Abbott Labs (ABT NYSE)

• Then: $107.90
• Now: $117.81
• Return: 9%
• Total Return: 11%

Artis REIT (AX-U TSX)

• Then: $11.44
• Now: $13.14
• Return: 15%
• Total Return: 22%

Enghouse Systems (ENGH TSX)

• Then: $53.41
• Now: $39.33
• Return: -26%
• Total Return: -25%

Total Return Average: 3%