Chris Blumas, portfolio manager, Raymond James Investment Counsel

FOCUS: North American large caps 

MARKET OUTLOOK:

If you look at the monthly inflation data in the U.S., headline inflation looks to have peaked several months back (June 2022) and the year-over-year comparisons get much tougher in the second half of 2023. Overall, this sets the stage for monthly inflation to continue rolling down from around six per cent currently to something around three per cent by the end of next year, if the current price level remains relatively stable.

The possibility of lower interest rates appears to be the main catalyst that has driven stock prices higher since the beginning of the year. However, the U.S. Federal Reserve and financial market participants seem to have different views of when interest rate cuts will occur. It appears unlikely that the Fed’s two per cent inflation target will be achieved in 2023 and this fact doesn’t support cutting interest rates before the end of the year.  

The modern economy is built on credit and higher interest rates hurt governments, businesses and consumers. With the U.S. national debt reaching an all-time high of US$31 trillion, significantly higher interest rates are likely to crowd out crucial public programs and critical defence spending. In addition, real-time data shows that commodity and home prices are deflating. Going forward, these price declines should help to shorten the current cycle of inflation and increase the possibility of interest rate cuts sometime next year.

While putting investment dollars to work in this uncertain environment can be daunting, equity market valuations have compressed significantly and the valuation risk embedded in the markets is much lower. Currently, the S&P 500 Index is trading around 18 times forward earnings and is roughly in line with its five-year average of 18.7 times. Going forward, I think investors should remain focused on earnings and cash flow and look for opportunities to acquire high-quality businesses that are currently out of favour.

Correction: In Tuesday's Market Call newsletter, the guest was incorrectly named. Stan Wong was the guest on the Feb. 14 episode.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

TOP PICKS:

Algonquin Power (AQN TSX)

Most recent purchase at $9.75 on 2023-02-10

Algonquin is a diversified utility with a mix of generation, transmission and distribution assets. The company generates the majority of its revenue in the United States and the majority of its profits from its regulated utility business. The last six months have been rough for Algonquin and its share price is down by more than 45 per cent. Last quarter, the company surprised the market with weak numbers and management pulled its guidance for 2023. Higher interest rates, higher taxes and more shares outstanding hurt profitability and surprised investors.

Earlier this year, Algonquin provided a business update and announced plans to reduce capex spending, increase asset sales and reduce its dividend by 40 per cent. These actions are intended to improve the company’s liquidity profile and protect its credit rating as it tries to complete the acquisition of Kentucky Power. These actions and the regulatory uncertainty surrounding the Kentucky Power acquisition have severely depressed Algonquin’s valuation and its shares currently trade at a 20-40 per cent discount relative to its peers. Going forward, I think that the company has good assets and management has a window of opportunity to turn things around and regain the confidence of investors. The shares currently trade at around 12x forward earnings and have a dividend yield of around per cent.

Walt Disney (DIS NYSE)

Most recent purchase at $111.93 on 2023-02-03

Disney is a global media and entertainment company. The company generates revenues by distributing original content, providing customer experiences at its parks and resorts and by selling consumer products. Disney shares are down by almost 30 per cent over the past year as concerns about profitability have negatively affected investor sentiment.

During its most recent quarterly update, newly returned Chief Executive Officer Bob Iger unveiled a transformation plan to reshape the company and improve profitability. The plan included new segment structures, the empowerment of content leaders and a $5.5 billion cost-savings plan. Disney+ subscribers remained relatively flat quarter-over-quarter at around 160 million. However the company’s parks and experiences business continued to perform exceptionally well with revenues and operating profits exceeding the pre-pandemic levels achieved in the first quarter of 2019 by 25 per cent and 32 per cent respectively.

Going forward, while it’s going to take Disney+ another year to become profitable, the company’s unique assets and digital capabilities strengthen its competitive position and create a platform that should help to drive future EPS growth. The shares are currently trading around 20x forward earnings for 2024 and a near 30 per cent discount to a conservative sum-of-the-parts valuation. Disney does not currently pay a dividend to shareholders but plans to reinstate one by the end of the year.

CVS Health (CVS NYSE)

Most recent purchase at $90.38 on 2023-02-09

CVS is an integrated health care company. The company has a unique business model that includes a network of retail pharmacies, a PBM and a health insurer. Earlier this month, CVS announced its intention to buy Oak Street Health, a primary care network serving older adults, in an all-cash transaction valued at $10.6 billion. While there is some uncertainty around health care reform over the long term, CVS has a strong competitive position across its business and the ability to deliver significant value to its customers. The company reported solid fourth-quarter 2022 results that highlight the resiliency of its business model and the strength of its cash flow generation. The stock is currently trading at around 10x forward earnings and has a forward-free cash flow yield of more than eight per cent.  

PAST PICKS February 16, 2022

Yum China (YUMC NYSE)

• Then: $52.40
• Now: $59.37
• Return: 13%
• Total Return: 14%

Great-West Lifeco (GWO TSX)

• Then: $39.39
• Now: $35.91
• Return: -9%
• Total Return: -3%

Enghouse Systems (ENGH TSX)

• Then: $41.52
• Now: $42.19
• Return: 2%
• Total Return: 4%

Total Return Average: 5%