Darren Sissons, vice-president and partner, Campbell, Lee & Ross

FOCUS: Global and technology stocks 

MARKET OUTLOOK:

For investors, December is always a tricky time of year, but more so this year given the complex trading environment in 2023. This year has been complicated to trade i.e., large market swings between risk on and risk off throughout the year. Equally so, larger accounts and especially flow-driven traders running large investment programs, who are underperforming benchmark returns, are reaching into year-end for larger gains and to preserve bonuses and jobs. For that same universe of investor, those that have outperformed index returns have closed out positions and locked in their gains. Consequentially, in a couple of weeks, we enter a new tax year so market sentiment could alter significantly.

There are three obvious macro risks the market is ignoring for now. First, the market is broadly assuming that Jerome Powell, chairman of the U.S. Federal Reserve, will cut interest rates in the first quarter, thereby triggering a soft landing. However, the U.S. is not in recession and labour markets there remain relatively buoyant, so the natural drivers of a rate cut are currently absent. Further, U.S. consumers with their 30-year fixed-rate mortgages are largely insulated from interest rate hikes. The better U.S. corporates have effective treasury management departments that favoured longer-term financing, which has also largely insulated their companies from higher interest rate pain. The pain is at the short end of the yield curve. Here in Canada, 45 per cent of mortgages outstanding refinance in 2024 at substantially higher rates. Similarly, countries with largely floating interest rate consumer debt now have weak economies. Consequently, the U.S. is currently trading as an island amid a sea of pain.

Second, the markets are climbing a wall of worry in terms of the continuing conflicts in the Middle East and Ukraine. We are probably overdue a supply issue for global oil, which many may recall drove the initial spike in inflation.

Third, a decline in U.S. interest rates will lower the U.S. dollar regarding major currencies. That decline would be a catalyst for commodities and would ultimately drive inflation.  

Looking offensively, companies with elevated dividend yields in a declining interest rate environment represent significant upside optionality. Its well-documented index returns are currently driven by a small, highly concentrated group of names. Concentrated ETF buying of the same names is largely the reason and has driven a multiple expansion in that small universe of stocks. Large capitalization technology companies in the U.S. or pharmaceutical companies selling weight loss medication are obvious examples of major index drivers. However, within indexes but beneath the highly-valued index constituents, in most developed markets across the globe, are a plethora of deeply discounted, high dividend-paying securities. Those deep-value names represent significant multi-year upside optionality as declines in interest rates are typically a catalyst for the reduction in dividend yields via share price appreciation. Many of these names offer substantially more income upside than bonds. There is also an increasingly large universe of stocks presenting idiosyncratic opportunities i.e., companies that sold off aggressively on company-specific issues. The market has excessively punished those names so upside optionality is also likely.  

On balance, be patient through year-end. Don’t chase the market. There is a substantial universe of wealth creation targets outside the highly-valued index constituents to target in 2024. Mean revision is always a risk for expensive names. Investors make money when they buy, not when they sell so be judicious when deploying capital and be open to non-consensus opportunities. 

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TOP PICKS:

Franco-Nevada Corporation (FNV TSX)

FNV is a high optionality name with a stellar long-term track record. It seldom goes on sale. Historically it’s been a mistake not to invest on major dips. The catalyst for the recent decline was a politically driven closure of the Cobre Panama mine run by First Quantum. That mine represents ~17 per cent of net asset value. The closure will trigger around 7,000 job layoffs in Panama, politically harmful lawsuits for the current Panamanian government in an election year and international arbitration unless a settlement is reached.

FNV has no debt and is typically the banker of last resort to mining companies during recessions and mining cycle bottoms.

Catalysts for higher earnings are a financial settlement or the resumption of operations in Panama and higher sustainable precious metal and oil prices.

The five and ten-year annualized total returns for FNV are 9.9 per cent and 14.9 per cent, respectively.

Royal Bank of Canada (RY TSX)

A well-known yield and total return engine currently yielding 4.4 per cent.

Canadian banks benefitted from a rise in net interest margin as interest rates re-rated from COVID-19 lock-down era lows to six per cent mortgage rates.

The expectation of higher credit losses as consumers progressively refinance low-interest rate debt into higher interest rates and the anticipation of lower net interest margin in 2024 has weighed somewhat on the franchise.

Royal Bank is well-capitalized, has a proven risk management culture and should weather a modest recession without difficulty.

The five-year annualized Total return of 3.7 per cent looks light versus its historical metrics so the franchise likely reverts towards the ten-year annualized Total Return of 10.8 per cent for investors with a reasonable timeframe.

LVMH Moet Hennessy Louis Vuitton SE (LVMH PA)

A total return juggernaut with a rising dividend. Given its luxury sector leadership, it enjoys both a defensive business model, as the wealthy tend to weather economic slowdowns well, and typically grows well above market growth rates.

LVMH is a proven, accretive consolidator of luxury brands and given its balance sheet is well-positioned to effect further acquisition-driven growth if opportunities present.

The company has generated five and ten-year annualized Total Returns of 25.1 per cent and 22.1 per cent, respectively.  

PAST PICKS:  AUGUST 24, 2022

Auckland Airport (AIA NZX)

• Then: NZD 7.52
• Now: NZD 8.42
• Return: 12%
• Total Return: 13%

Chocoladefabriken Lindt & Spruengli AG (LISP SWX)

• Then: CHF 10700
• Now: CHF 10910
• Return: 2%
• Total Return: 3%

Shell Plc (SHEL NYSE)

• Then: US$54.44
• Now: US$64.69
• Return: 19%
• Total Return: 25%

Total Return Average: 14%