Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

Rapid increases in interest rates have undermined stocks, bonds and real estate globally. We have almost reached the “enough is enough” point though, with most of the upward pressure on rates behind us. But with overnight rates between four and five per cent, monetary policy is firmly in the restrictive territory and is unambiguously easing inflation while also slowing the economy. Interestingly, expectations on Main Street have recalibrated to a weaker economic environment, with consumer and business confidence, retail sales and various other indicators pointing to a sobering outlook for 2023. Expectations of professional analysts and Wall Street strategists for corporate profits remain far out of step with the prevailing backdrop. 

These pie-in-the-sky, rosy corporate earnings forecasts will likely come down sharply. We have actively sought to avoid the sting of that resetting of expectations by investing mainly in companies where earnings visibility is high and conversely earnings estimate risk (measured by analyst forecast dispersion) is low. Companies we own on average have earnings forecast dispersion that is 40 per cent below the typical company. The process of resetting expectations is vitally important in setting the stage for a new bull market. We have structured portfolios so as to observe the process safely from a distance, as opposed to getting steamrollered by it. We know back-to-back annual losses in stocks are extremely unusual, having occurred only twice in the last half-century, in 1973-74 and in 2000-02. We don’t expect 2023 to be easy but we do expect a new bull market to begin this year. An active approach within portfolios will be critical this year because what works heading into the fundamental lows in the market will almost certainly lag during the recovery, coming out of the trough. As such, we expect, plan and look forward to being very busy this year. 

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TOP PICKS:

Alibaba Group Holding (BABA NYSE)

Last purchased in January 2023 at $115.82

Alibaba is the leading e-commerce and cloud provider in China. Chinese cloud spending lags behind the rest of the world at just seven of overall I.T. spend and thus is expected to grow at 30 per cent per year over the medium term. China’s middle class is growing at 11 per cent per year and is spending more and more on discretionary goods, with online sales already at 50 per cent penetration and growing eight per cent per year. Since late 2020, the stock has been punished by COVID-19 lockdowns and punitive internet regulations in China. The shares have begun to recover but remain 60 per cent below the 2020 peak, offering an attractive valuation at 9x enterprise value to EBITDA versus the historical average multiple of 14x and thus a compelling entry point. China stands out as one of the very few regions globally that will see a reacceleration in economic growth this year, with continued accommodative monetary policy and the economy finally reopening, post-pandemic.

Fairfax Financial (FFH TSX)

Last purchased in December 2022 at $809.26

Fairfax is a leading global insurer with home, auto and specialty lines of business, among others. In its core insurance underwriting business, it is booking combined ratios in the mid 90’s – some of the best underwriting margins they’ve earned in 10+ years, as the entire industry benefits from tight underwriting capacity and good pricing power. Its $53 billion investment portfolio is $35 billion invested in cash and very short duration, high credit quality bonds and will benefit enormously this year from reinvestment at higher interest rates as the bonds mature. The shares trade at 1.1x book value and a scant 7x expected 2023 earnings, both deeply discounted versus insurance peers and versus its own historic average trading multiples.

Fortis (FTS TSX)

Last purchased in Febuary 2022 at $57.67

Fortis has grown mightily from its humble roots as Newfoundland Light & Power Company to become Canada’s largest utility with ownership of ten locally operated gas and electric utilities across Canada, the United States and the Caribbean. Ninety-nine per cent of its assets are rate-regulated, which ensures shareholders recoup the full costs of doing business as well as a competitive return on its invested capital regardless of changing business and financial conditions or commodity prices. The shares offer a dividend yield of four per cent and that dividend has been increased 49 consecutive years in a row. Plans to sustain a four to six per cent compound growth rate in the dividend over the next five years are well supported by the company’s robust $22 billion slate of capital expansion projects.

PAST PICKS: January 11, 2022

TFI International (TFII TSX)

• Then: $126.09
• Now: $142.49
• Return: 13%
• Total Return: 14%

Bank of Nova Scotia (BNS TSX)

• Then: $91.81
• Now: $68.97
• Return: -25%
• Total Return: -21%

Nutrien (NTR TSX)

• Then: $88.05
• Now: $105.01
• Return: 19%
• Total Return: 22%

Total Return Average: 5%