John Zechner, chairman and founder, J. Zechner Associates

FOCUS: North American large-cap stocks

MARKET OUTLOOK:

In July, growth stocks pushed the Nasdaq up 12 per cent, cyclical stocks lagged, gold bounced up nearly $100 and 10-yr bond yields fell almost a full point from the mid-June peak. Markets, rightly or wrongly, have clearly bought into the idea that growth is slowing and U.S. Federal Reserve is closer to ‘done’ on rate increases. 

We think it is far too early to start to price in an end to the rate hiking cycle. We are a long way from seeing a reversal in Fed policy like we saw at the end of 2018 after stocks had dropped over 20 per cent. Central banks have only just begun their tightening while inflationary expectations have become somewhat ‘embedded.’ While experts may debate whether or not the U.S. is in recession after two consecutive quarters of negative growth, the reality is that economic growth is slowing down. This should mean that inflation has peaked for the cycle, but the return back to the two per cent target will take longer than expected, even with the recent decline in many commodity prices. 

Meanwhile, the slowdown means that earnings estimates will have to come down further. Despite these headwinds for growth and earnings, we are maintaining a neutral weight in stocks. Valuations have compressed sharply since the beginning of the year and many sectors (i.e. consumer discretionary) are already reflecting recessionary conditions. Most importantly though, investors are positioned quite bearishly, which should limit the downside in stocks from here. Bank of America’s monthly fund manager survey, global growth and profit expectations sank to an all-time low, while recession expectations were at their highest since May 2020. Investor allocation to stocks plunged to levels last seen in October 2008, while exposure to cash surged to the highest since 2001. The net short position in U.S. equity futures at ~$60B while the gross short position reached an all-time high of ~$370B.  Levels like these are only seen around market lows.

In the last month, we added to positions in core U.S. tech stocks including Alphabet, Microsoft, Qualcomm, Paypal and AMD; also positions in GM, FedEx, Magna, BRP, Air Canada and U.S. financials (Citi, Amex and JP Morgan) on first-half weakness. Additionally, we see opportunities in energy, where the stocks dropped over 20 per cent in the June-July period despite trading at record low valuations. But the forces keeping energy prices high are enduring, whether there is a recession or not. Key names in the oil sector that we have been adding include Crescent Point, Whitecap Resources and Cenovus as well as natural gas producer Arc Resources.

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TOP PICKS:

Alphabet (GOOG NASD) 

Last bought US$105 – June 2022 

Alphabet continues to stand out as the best combination of growth and valuation in the tech sector. While dominant positions in search and online advertising drive the narrative, the company is also a major player in cloud services as well as having huge value in under-monetized assets such as the Android operating system for wireless devices, YouTube and Waymo (automated driving). Ad markets have slowed down in the short term but the low valuation more than offsets that risk.

General Motors (GM NYSE) 

Last bought US$31 – June 2022

If Tesla can command a market cap near a trillion dollars, then GM should be worth more than $56 billion. Especially considering that it produces over six times as many autos annually.  GM has plans double revenue to about $300 billion by 2030, including $90 billion in sales of electric vehicles. GM also has a controlling stake in Cruise, a top player in autonomous driving that plans to roll out robo-taxis. The company can finance this growth from its legacy combustion engine business, yet still trades at earnings multiple well below that of the overall market. Investors are skeptical that GM can manage the EV transition and achieve those goals, but the stock already discounts a lot of doubt.

Agnico Eagle Mines (AEM TSX)

Last bought $50 – July 2022 

Gold stocks have lagged massively over the past year as the surging U.S. dollar and rising interest rates pushed gold back down from record lows. Meanwhile, valuations in the sector have sunk to multi-decade lows, with most names trading at five times cash flow and discounts to net asset value, well below historical levels. Agnico remains a ‘go to’ name in the sector for large-cap exposure, low political risk (bulk of assets in Canada, the U.S. and Australia) and growth from the recent merger with Kirkland Lake Gold (which, in turn, had acquired Detour Lake Gold last year).