Darren Sissons, vice-president and partner at Campbell, Lee & Ross

FOCUS: Global and technology stocks

MARKET OUTLOOK:

An interest rate regime change is now in effect. Largely, since the onset of the 2008 global financial crisis, interest rates have been in structural decline, driven by highly accommodative monetary policy. That strategy ended with Canada and New Zealand both raising rates by 0.50 basis points last week and more importantly because the U.S. is widely expected to raise interest rates by an equivalent 50 basis points on May 9th.

The higher cost of capital will dampen demand and slow global growth. Equally so, China’ zero COVID strategy and the war in Ukraine will also lower global demand. Given the regime change and the drag from China and Ukraine, two large risks remain as yet unquantified i.e. how high will interest rates rise and how likely is a policy error?

Currently, the markets response to those questions is a mixed message as interest rates are rising quickly but the pricing of the Government of Canada (“GoC”) three-year bond is only marginally lower than the 10-year GoC bond. The narrow spread suggests two alternatives. First, short term interest rates will rise and then decline as inflation spikes then subsides. Alternatively, long-term interest rates will rise and remain elevated due to higher sustained inflation over the next few years.

A quantum change in monetary policy has major implications for the markets. Looking to equities, a rising cost of capital is a catalyst for market rotation. COVID success stories and meme stocks, in particular, saw large declines since peaking in early 2021. Should interest rates continue rising as expected, further downside for growth stocks is inevitable. Interest rate sensitive sectors, such as banks, recently sold off due to concerns over rising loan delinquencies but longer-term financials will benefit from higher rates. Value will continue to benefit from the transition to higher interest rates. COVID recovery trades including energy and commodities, as mentioned in prior appearances, should also provide leadership moving forward.

Given the above, the marching orders are clear. 1) Continue rotating portfolios into areas that benefit from higher interest rates and inflation. 2) Re-evaluate fixed income exposure vis-à-vis the pending negativity from rising interest rates. 3) Use the strong Canadian dollar while we have it (note: currency strength seldom lasts) to buy inexpensive quality outside Canada. 4) Add exposure to COVID recovery plays. 5) Use market volatility to inexpensively and tax efficiently re-balance portfolios.

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TOP PICKS:

Bank of America (BAC NYSE)

1. U.S. banks are well positioned to benefit from rising rates. Unlike Canada, where consumers added significant debt in the last few years, the debt load of the average U.S. consumer is relatively low and the U.S. economy is powering out of COVID induced recession.
2. Higher interest rates will drive earnings growth for conventional banking. Wealth management and investment banking should also see growth opportunities as the U.S. economy transitions to higher rates.
3. Given the recent share price decline, the company offers an attractive entry level for new investors.
4. The bank currently yields 2.24 per cent.

Novartis AG (NOVN SWX)

1. A global pharmaceutical behemoth with several near-term catalysts including: i) Novartis exited it’s Roche shareholding in 2021, realizing US$21 billion in proceeds, ii) Management are evaluating the divestiture of Sandoz, its generics business, iii) The pipeline is undervalued with several promising opportunities, iv) Management have a large war chest to execute the accretive tuck-in acquisition strategy to bolster growth.
2. A growing dividend yielding 3.6 per cent and an active share buyback program.  

Saputo Inc (SAP TSX)

1. An undervalued Canadian champion with substantial North American exposure and a growing international footprint.
2. The high Canadian dollar is currently dragging on the profitability of non-Canadian operations.
3. Expect continued tuck-in acquisitions moving forward.
4. Saputo is a COVID exit recovery trade as sales should rise as consumers increasingly return to the office and social settings.
5. The Saputo family own +30 per cent of the company and are managing it for longer term shareholder growth.
6. The discounted share price offers new money an attractive entry level.

PAST PICKS: April 23, 2021

CN Rail (CNR TSX)

• Then: $135.85
• Now: $160.60
• Return: 18%
• Total Return: 20%

Royal Dutch Shell (SHEL NYSE)

• Then: $38.03
• Now: $57.31
• Return: 51%
• Total Return: 52%

Tencent Holdings (700 HKG)

• Then: HKD 632.00
• Now: HKD 374.00
• Return: -39%
• Total Return: -39%

Total Return Average: 11%