Darren Sissons, partner and portfolio manager, Campbell, Lee & Ross Investment Management

FOCUS: Global and technology stocks 

MARKET OUTLOOK:

Equity markets are rallying, based on the pricing-in of significant interest rate cuts, which is then triggering a heavy dose of the “fear of missing out.” However, recent economic data and comments from U.S. Federal Reserve Chairman Jerome Powell, suggest that the expectation of a succession of rate cuts in 2024 may be wrong, or at best overly optimistic. While weakening economic fundamentals are on display in most developed economies and the bigger emerging economies, the degree of weakness is currently low to medium. The key dilemma for central bankers toying with rate cuts is the transmission mechanism. Specifically, how much damage has been done already by 11 interest rate increases and how quickly can that as yet unknown damage be minimized? Equally so, if central banks cut rates too quickly, inflation will remain unanchored necessitating higher interest rates in the future to counter sticky inflation.

Looking beyond interest rates, market pundits point to tensions in Europe, the Middle East and Taiwan as reasons for concern. Wars are simulative and inflationary as Poland’s economy is proving. However, ignoring the human dimension of those actual and potential conflicts, they remain largely regionalized skirmishes. On balance, while newsworthy, inflationary and perhaps economically simulative to their respective regions, those conflicts are unlikely to move the markets unless the scale and scope of conflict escalates substantially beyond current levels.  

The highly concentrated nature of current index performances is a concern I noted previously. Nvidia was up 200 per cent last year but down 70 per cent in 2022. Meta Platforms was up 19 per cent last week on the announcement of a dividend introduction, which typically indicates growth is slowing. Both names, of course. are major index drivers. Further, many of the momentum-driven names are trading at plus one standard deviation, which is not sustainable. However, momentum names aside, the lion's share of markets are trading at significant discounts to their historical valuation metrics and therefore represent excellent risk-reward opportunities.

Given the above-noted risks, we see upside potential in financials, commodities, Asia and non-index dominating equities. In fixed income, two seven-year bonds look reasonably attractive in a laddered structure as well.

• 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:

BHP Group (BHP NYSE)

A global mining behemoth exposed to coal, copper, iron ore, nickel, and potash. An attractive dividend yielding 5.7 per cent. Its share price is currently expressing negative concerns over Chinese commodity demand as BHP is a major commodity supplier to China. However, China has recently introduced a range of stimulus policies that should provide upside to Chinese commodity demand. Commodity prices are a net beneficiary of inflation, which should support metal prices. Commodity companies are highly cyclical so should be dated not married. When on sale BHP offers a compelling risk-reward profile.

Royal Bank of Canada (RY TSX)

The dividend, currently yielding 4.2 per cent, has risen at an average annual rate of 7.8 per cent for a decade. The buyback program has averaged around one per cent per year over five years. Inflation remains above target so interest rates will remain higher for longer. NIM (net interest margin) will therefore continue to benefit from higher rates. The bank is well capitalized and should credit losses spike, there is ample capital to manage through a weak economy or recession.

Shell (SHEL NYSE)

A 3.7 per cent dividend yield. Share buyback program averaged 16.4 per cent per annum over the last five years with a further $3.5 billion scheduled for the first quarter 2024. Attractively priced given the ESG overhang. Financially disciplined with low debt. Energy is historically a net beneficiary of inflation. Sustained or unanchored inflation will support higher energy prices and higher Shell earnings. The rising dividend yield plus the buyback should drive an annualized total return of 10 per cent or better for the foreseeable future.