Jason Mann, co-founder and chief investment officer at EHP Funds
FOCUS: North American equities

MARKET OUTLOOK:

It’s been a volatile quarter for markets overall with the double whammy of a hawkish U.S. Fed, and the invasion of Ukraine. Bond markets have seen their worst peak-to-trough sell-off in decades, and most equity indices have seen meaningful pullbacks before rallying furiously into the end of the quarter.

Canada has been a relative winner, with its direct exposure to commodity markets, which have moved sharply to the upside on supply concerns.

Government policy is set to make these commodity shortages worse. The Pandora’s box of stimulus cheques that was opened during the pandemic is being used again to offset expensive gasoline. Of course, paying people to buy more gasoline at high prices will only result in higher prices, but the populist appeal is strong, and we expect to see it continue.

With yield curves now flattening, there is increased talk of recession. The yield curve has an enviable track record of predicting slowdowns, but the timing after an inversion is less clear. We do think there is a real risk that the Fed is hiking rates into an economic slowdown. Whether or not that slowdown results in a recession or not, markets may find it tough to make much headway.

We have possible “stagflation,” where inflation increases as growth slows from its peak.

In a stagflation environment, you want a barbell approach of stocks that benefit directly from inflation: commodities and related businesses, as well as high-quality, larger-cap stocks with strong earnings growth (as opposed to speculative top-line growth).

We’d still avoid unprofitable tech as there can be no bottom for them if the market resumes its downturn, but we think there are opportunities in high-quality, profitable tech.

We’re overweight high-quality cyclicals in energy, materials (fertilizers, copper, steel), as well as related construction and transportation businesses. We’re avoiding or are net short expensive growth stocks and bond-proxy sectors like utilities.

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TOP PICKS:

Archer-Daniels-Midland (ADM NYSE)

ADM is one of the world’s largest agriculture firms, with businesses from processing to transportation to storage. They convert corn, oilseeds, wheat etc into food products, animal feed, industrial and energy uses. The reality today is that the world is short energy and is short protein. Food inflation is becoming a major concern and is set to continue, in particular if geopolitical challenges persist given the crops that come from Ukraine and the fertilizers that come from Russia and Belarus.

This pick is thematic in that sense – while prices for most of these commodities has gone vertical and should pull back on any resolution of the war, there is likely to continue to be upward pressure longer-term as there are structural deficits in global food markets. As prices go, so do margins for processors and distributors like ADM.

Scores well for us on all three of our metrics – in the top 20 per cent of S&P 500 stocks on momentum, value and low volatility.

Solid balance sheet, small yield at 1.7 per cent but payout ratio is very reasonable, has respectable valuation metrics on PE (16x), and EV/EBITDA at 13x.

Capstone Copper (CS TSX)

We like copper in general as one of the commodities that should do well during periods of inflation, and as a key metal for the electrification of infrastructure that comes with the move to clean energy. Copper is another commodity that is undersupplied relative to demand, and its not easy or fast to bring on new mines.

Capstone Copper is the result after their recent merger with Mantos Copper, which reduces balance sheet risk, and doubled down on their operations in Chile, one of the worlds best mining jurisdictions, and adds to their operations in Mexico and Arizona.

Essentially, they are moving up the ranks from a small cap historically to a more mature, diversified mining company which reduces risk and should broaden their investor base.

Scores well for us on both valuation and price momentum. 5.7x Price-to-free-cash flow, 4.9x EV/EBITDA, 10x forward PE and a recent beat on earnings. No net debt, so no issues with balance sheet if the commodity turns lower.

Enerplus (ERF TSX)

Clearly, over the last year or so you could have picked just about any energy stock and returns would have been remarkable. After a five-year bear market (and negative $40 oil during the pandemic), its clear that the world is now short energy in all forms, and oil has become a key driver of inflation.

We don’t think that the structural reasons why this has been true will be solved anytime soon. In many ways, government and social demands for more environmentally-friendly energy production has made the problem worse in the short run – there has been underinvestment, and a lack of policy to encourage new traditional production. Essentially, we’re forcing transition before we have the supply from green energy, and so this may persist for some time.

PAST PICKS: April 9, 2021

Shaw Communications (SJR/B TSX)

• Then: $33.57
• Now: $39.01
• Return: 16.02%
• Total Return: 19.74%

Bank of Nova Scotia (BNS TSX)

• Then: $78.32
• Now: $91.52
• Return:  16.85%
• Total Return: 20.44%

Ameriprise Financial (AMP NYSE)

• Then: $240.79
• Now: $310.08
• Return: 28.77%
• Total Return: 30.65%

Total Return Average: 23.61%