Shane Obata, portfolio manager, Middlefield Capital

FOCUS: Global large-cap stocks

MARKET OUTLOOK:

June was an extremely volatile month for equities with the S&P 500, TSX Composite and MSCI World, all declining by more than eight per cent. The S&P 500 closed the first half of 2022 in a bear market, down 20.6 per cent, making it the worst start to a year since 1970. No S&P 500 sectors except energy generated a positive return in the first half, leaving few places for investors to hide.

Despite the widespread weakness experienced in the first half, we are starting to see signs of reprieve in key areas of the economy, particularly inflation. Underlying forces are starting to shift in a more favourable direction which should act as a catalyst for improving investor sentiment. Major retailers including Target, Walmart and Best Buy are starting to cut prices aggressively in an effort to liquidate inventories that have accumulated because of logistical challenges. Commodity prices are declining rapidly with the rolling 20-day average of the Bloomberg Commodity Index seeing its third largest decline in 90 years. As a result, we are now seeing a corresponding decline in future interest expectations, with the market starting to price in rate cuts as early as the second quarter of 2023.

We believe we are in a cyclical bear market which is a function of rising rates and inflation combined with lower profit expectations. Given the impacts that inflation and higher interest rates will have on demand, we expect a mild slowdown in economic activity this year. Much of this is already being priced into markets today, reflected in the S&P 500 forward earnings multiple declining from 21x to below 16x. Although it may not show up in the June CPI report given the lagging nature of data, we believe we are at peak inflation and should start to see some incrementally less hawkish data points throughout the summer. Sell-side earnings estimates have started to come down and we expect a deceleration in growth over the coming quarters; however, household and corporate balance sheets remain strong, which supports our view of a mild slowdown only. Against this backdrop, we are focused on companies with high margins, strong balance sheets and stable dividends.

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TOP PICKS:

Nvidia (NVDA NASD)

Purchased at US$151.26 on July 13, 2022

Nvidia (NVDA) remains one of our top picks in the semiconductors industry. The company is a leader in GPU technologies, with a dominant market position. NVDA is known for gaming but the larger opportunity we see is in high-performance computing and AI applications. Macro headwinds and a reduction in demand from the crypto market may weigh on short-term results in the client (gaming) business. Even so, we continue to expect robust demand from the data center, which is now NVDA’s biggest end market. The stock currently trades at a forward P/E of ~31x, which is well below its five-year average of ~38x. While NVDA trades at a significant premium to the industry, we believe this is warranted due to its leadership position and solid growth prospects.

Motorola Solutions (MSI NYSE)

Purchased at US$214.64 on July 15, 2022

Motorola Solutions (MSI) is one of our favourite ideas within the tech hardware industry. The company is largely driven by its legacy LMR division, which consists of radio communication technologies that keep people safe, connected and effective across various public safety and enterprise security end markets. We view this segment as highly defensive and believe that it will be a surprise to the upside, supported by a robust backlog and easing supply chain constraints. MSI also provides access to the highly attractive video security and access control market, which stands to benefit from a well-justified increase in government support for public safety initiatives. As the company continues to transform its business mix from hardware to software, we expect that recurring revenues will become an even greater part of the business mix, leading to higher profitability and multiple expansion in the years to come.

LVMH (MC FP)

Purchased at €592.29 EUR on July 15, 2022

Note: Please refer to the local listing (France), not the ADR

We view LVMH as the global leader in luxury goods. The group comprises of 75 Maisons, which span across five segments: Wines and spirits (Veuve Clicquot), fashion and leather goods (Louis Vuitton, Dior), perfumes and cosmetics (Givenchy, Fenty), watches and jewelry (Hublot, Bulgari, Tiffany) and selective retailing (Sephora). With a long history of operational excellence, we believe that LVMH is well positioned to outperform regardless of how economic conditions evolve. We are expecting “better-than-feared” results when the company reports on July 26, with strength in the U.S. and Europe offsetting (well-known) weakness in China due to COVID-19 restrictions in the period. LVMH currently trades at a premium multiple of ~22x, which is nearly one standard deviation below its five-year average of ~26.2x.

 PAST PICKS: August 9, 2021

Amazon (AMZN NASD)

• Then: $3341.87
• Now: $125.31 (20-for-1 stock split June 6th)
• Return: -25%
• Total Return: -25%

Taiwan Semiconductor (TSM NYSE)

• Then: $118.22
• Now: $87.33
• Return: -26%
• Total Return: -25%

Uber Technologies (UBER NYSE)

• Then: $43.25
• Now: $24.25
• Return: -44%
• Total Return: -44%

Total Return Average: -31%