John Zechner, chairman and founder, J. Zechner Associates

FOCUS: North American large-cap stocks

MARKET OUTLOOK:

The first stage of the sell-off in stocks (which took the S&P 500 down 20 per cent and the Nasdaq almost 30 per cent) was almost entirely due to the re-valuations of ‘high multiple growth stocks.’ To move into a full-blown bear market, we would need to see the ‘second shoe’ drop and earnings start to miss expectations and/or companies reduce forward guidance. Despite the rise in interest rates, the bullish case for stocks was that earnings were still growing despite rising inflationary pressures. That narrative has started to change as Microsoft, Apple, Snap and Amazon pointed to currency pressures and the shutdown in China as impacting demand and costs. Then leading retailers such as Walmart and Target (twice in three weeks!) showed the negative impact of higher wages, ongoing supply chain problems and rapid changes in consumer preferences, leading to some inventory mismanagement and price markdowns. These ‘earnings warnings’ are the next big risk for the stock market and could be most apparent over the next two months.   

In terms of our current investment strategy, we remain constructive towards stocks despite the risks. We have seen the multiple on the S&P 500 fall from over 21 times to around 16 at the recent low, close to the long-run average. We recognize that in any bear market stocks rarely stop falling at ‘fair value’ and generally bottom at much lower levels, we believe that central bankers may not need to be as ‘hawkish’ as they currently appear since we don’t see inflation being endemic like it was in the 1970s. Wage pressures have not become built-in to the same degree, increasing capacity and slowing economic activity will reduce goods shortages and, most importantly, technological innovation continues to be a source of disinflation and increased productivity. While the key market risk is that this strong medicine for inflation could set off a recession, the economic and earnings data have yet to reflect that outcome. For now, jobs are abundant, wages are rising, and household and corporate balance sheets look strong. Stay tuned!

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TOP PICKS:

General Motors (GM NYSE)

Latest purchase US$36 – May 2022      

The auto stocks have had a dismal year as worries about the impact of slowing economic growth on industry sales, production issues from the chip shortage and rising material costs from commodity shortages have all weighed on investor sentiment in the sector. Yet GM is only trading at seven times forward earnings and is generating strong positive cash flow, which it continues to invest in new growth initiatives in both electric vehicles and autonomous vehicle technology, with its Cruise segment recently approved for operation in San Francisco, ahead of Waymo or Tesla. While its ICE business will deteriorate over time, the established brands and long history of auto production should allow it to migrate smoothly to EV production. 

Walt Disney Company (DIS NYSE)

Latest purchase US$106 – June 2022 

Disney has traded down almost 50 per cent from its 2021 peak, yet most of its core businesses are in better shape and benefit from the ongoing reopening of the global economy. Parks numbers have been huge despite not being fully open yet in Europe or China. The Marvel, Pixar, Lucas Film and Fox acquisitions have all added to the industry-leading media library, which is being rolled out on Disney Plus. Disney also cross-sells its film properties to the parks, merchandise, television and games better than anyone else in the industry. While the PE valuation is at the high end of the relative range, this is solely due to the investments in the streaming business to get it up to critical mass. The ‘sum of the parts’ valuation is at historically low levels.

Qualcomm (QCOM NASDAQ)

Latest purchase US$132 – May 2022.  

 We view the semis as the best source of growth in the industrial sector. We have seen extraordinary demand for semiconductors over the past few years due to the effects of the pandemic as the work-from-home era has spurred sales of laptops, cell phones, appliances, autos and other personal use items, all of which come with customized chips. Qualcomm is a leader in the supply of cell phone chips for the 5G market and has successfully expanded into I0T (Internet of Things). The growth of cloud servers and 5G communications will further spur growth in the industry. The valuations are excessively low at only about 12 times forward earnings despite a growth trajectory that now looks more secure.

PAST PICKS: June 18, 2021

 Martinrea International (MRE TSX)

• Then: $12.98
• Now: $9.14
• Return: -30 per cent
• Total Return: -28 per cent

 MDA Ltd. (MDA TSX)

• Then: $15.69
• Now: $8.70
• Return: -45 per cent
• Total Return: -45 per cent

VanEck Vectors Semiconductor ETF (SMH NASD)

• Then: $246.93
• Now: $229.66
• Return: -7 per cent
• Total Return: -6 per cent

 Total Return Average: -26 per cent