Teal Linde, manager, Linde Equity Fund

FOCUS: North American mid and large-cap stocks

MARKET OUTLOOK:

Our year-end 2021 outlook stated some reasons why we were doubtful that the S&P 500 could deliver a fourth consecutive year of 15 per cent-plus returns in 2022. We started by recognizing that a bull market that was doubling historical returns was unlikely to continue such a strong performance. We noted that this strong performance had led to very high market valuations (a price-to-earnings ratio above 23 to start the year) and that with central bank asset purchases about to end and interest rates potentially rising, valuations would have a hard time moving higher from opening-year levels. We also observed that earnings growth was expected to be 9 per cent in 2022, driven by higher profit margins, which might also be hard to achieve.

Since its peak on the second trading day of January, the S&P 500 has lost about one-quarter of its value. Interestingly, the bulk of this decline has come from a decline in valuations. This has brought the S&P 500 price-to-earnings ratio to below 17, around average in recent decades. The recent price declines have largely addressed valuation concerns.

Durability of earnings is now the key question. Will interest rate hikes, that central banks are instituting to fight inflation, cause a recession? And if so how badly may earnings contract? Right now, analysts are not anticipating any decline in earnings, with S&P 500 earnings estimates for 2022 about 2 per cent higher now than they were to start the year. 

A recession-induced decline in earnings has become the key potential risk for the market. Valuations are now less of a concern. With 2022 on track to deliver the worst first-half performance for the S&P 500 since 1962, downward pressure on the market may abate in the second half, with fluctuations centred around economic prospects.

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TOP PICKS:

NATIONAL BANK OF CANADA (NA TSX)

Last purchased on April 20, 2022 at $94.75

National Bank may not be one of the big five banks in Canada, but its stock has been the number one performer over the last 10, 12 and 15 years, on a calendar year basis both on a price appreciation only basis and price and dividend basis. The bank enjoys broad-based strength across all of its business lines. With its overweight exposure to Quebec, the bank also has less relative exposure to a potentially overheated housing market in Ontario. Part of the bank’s advantage of being smaller than the big five is its valuation discount which allows it to enjoy a higher relative dividend yield and the ability to proportionally buy back more stock than its larger typically more expensive peers. National Bank also consistently has one of the highest ROEs among the Canadian banks. Its stock is now trading at the low end of its historical valuation range at nine times earnings.

AIR CANADA (AC TSX)

Last purchased on November 23, 2020 at $21.56

Air Canada’s booking data through the end of May points to Q2/22 net passenger revenues tracking 8.8 per cent below the same period in 2019. North American demand is leading the recovery, followed by Atlantic markets and then Asia. Yet despite enjoying the strongest revenue improvements since the pandemic began, Air Canada’s stock recently fell back to 2020 price levels as part of the recent stock market rout. Benefitting from a combination of tight capacity and pent-up demand, Air Canada’s stock appears oversold and well-positioned for a bounce-back upon stabilizing market sentiment.

ENSIGN ENERGY SERVICES (ESI TSX)

Last purchased on February 7, 2022 at $2.25

With higher oil and gas prices, Ensign expects higher equipment utilization across its Canadian and U.S. operations, which is expected to drive increased day-rate prices. Management remains focused on increasing margins over market share. The company is also focused on debt reduction while taking advantage of improving pricing dynamics with its current relatively short-term price contracts. With oil and gas prices at eight and 14-year highs, respectively, Ensign is still far below its $6 trading price of just over three years ago. With energy security returning to center stage, Ensign’s prospects are favourable.