John Zechner, chairman and founder of J. Zechner Associates

FOCUS: North American large-cap stocks  

MARKET OUTLOOK:

While the tailwinds all still favour the big tech stocks, it feels like we are in the “blow off” upside phase of the market bounce that started last November. We are getting into “rarefied air” in terms of valuations and it is hard to see how future expectations can be justified. Technology stocks still have all the momentum for now, accounting for all of the earnings growth in the past year and benefitting from an expected round of interest rate cuts and continued buildout of the AI infrastructure. There are some other warning signs though that we should pay attention to. This may not be 1999 and we agree that the tech leaders today have real earnings and cash flow as opposed to “eyeballs” and “dot com” labels back then, but there are also many similarities that are not getting talked about. 

The final surge in the Nasdaq Index in 2000 was also very narrow, driven by the few large telecom and equipment companies that were building out the cable and fibre that would power the internet. Nortel, Lucent, Cisco and JDS Uniphase led that charge and telecom newcomers such as Worldcom were paying for that expansion. However, once that initial backbone was largely completed, the sales from those giants fell off a cliff and only one of those companies is still around today. While the next leg of spending on AI will accrue to the leaders in the applications layer that implement the large language learning models that power AI. This is not unlike how we expected the software and web service companies in 2000 to take over the next phase of growth once the internet infrastructure was built out. Companies such as Microsoft and Oracle took those roles and grew throughout that entire post 2000 era. But it took both of those stocks 15 years to get back to the levels seen in 2000, so valuations did matter. We are starting to shift investments out of tech into cash and looking for buying opportunities in the rest of the market on any pullbacks.  

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TOP PICKS:

MDA (MDA TSX)

MDA is a market leader in geointelligence and earth observation (EO) data and satellites; robotics; and satellite systems. Demand for space-based industries and businesses is accelerating, driven by satellite cellular and internet service, missions to the Moon and Mars, new space stations and demand for space infrastructure and commercial services from defence and intelligence organizations. The award of lead contractor on the Telesat LEO project added over $1.5 billion to the backlog and secures double digit growth in cash flow over the next five years. MDA Space also just won a $1-billion contract with the Canadian Space Agency for the next phases of the Canadarm3 robotics system. The stock remains largely undiscovered within its peer group and still trades at a discount to the group despite superior growth and much improved financial performance. 

Capital Power (CPX TSX)

Capital Power is a North American independent power generation company based in Edmonton which develops, acquires, owns and operates power generation facilities using a variety of energy sources. We view CPX's ability to build, optimize, and add value to dispatchable assets critical for system reliability as attractive given broad tailwinds for electricity demand. This is underpinned by a growing need for reliable electricity in its core markets, where it has assembled a high-quality thermal asset base and complementary renewable power development. The stock has a reasonable valuation, a strong pipeline of growth projects and a fully funded six per cent dividend yield. 

Torex Gold (TXG TSX)

Canada-based intermediate gold-producing company, which is engaged in the exploration, development, and operation of its Morelos Gold Property, located 180 kilometres southwest of Mexico City. The company has done an admirable job offsetting the decline and ultimate closure of the El Limon open pit and replacing it with the Media Luna deposit, which is an advanced-stage development project located approximately seven kilometres from the ELG processing plant and related infrastructure. Moreover, once fully up and running, the Media Luna deposit will generate 30-40 per cent of the value of production in copper, thereby also participating in the bullish outlook for the “red metal.” The company has a stellar balance sheet with enough excess cash to fully develop the Media Luna facility and begin to generate free cash flow again.   

PAST PICKS: MAY 30, 2023

VEREN (VRN TSX)

• Then: $6.53
• Now: $7.86
• Return: 20%
• Total Return: 28%

Rogers Communication (RCI.B TSX)

• Then: $44.39
• Now: $36.69
• Return: -17%
• Total Return: -14 %

Pfizer (PFE NYSE)

• Then: US$37.01
• Now: US$27.97
• Return: -24%
• Total Return: -20%

Total Return Average: -2%