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

FOCUS: Global and technology stocks 

MARKET OUTLOOK:

Investors continue to operate in a tactical market, which requires active management. A well-managed buy-and-hold portfolio methodology is a proven value-creating strategy longer term. However, that strategy is not optimal during periods of heightened and sustained market volatility. A better approach is a modified buy-and-hold strategy that includes opportunistic trading.

Rising interest rates and the conclusion of quantitative easing are the driving forces of heightened market volatility. Investors are now re-evaluating exposures while transitioning out of growth into safer defensive sectors and are increasing exposure to fixed income. The natural consequence of rising volatility is securities (commodities, equities, fixed income and interest rate-linked products) have a tendency to overshoot the price range justified by underlying fundamentals. That temporary mispricing leads to opportunities to trim core holdings to extract unsustainably large capital gains or to profitably divest a mature position. Equally so, oversold securities represent an excellent opportunity to deploy capital at inexpensive valuations.

Given the tactical market backdrop, the first half of 2023 is likely to experience continued market volatility. Inflation is driving costs higher. Currency, for U.S. companies in particular and Canadian companies to a lesser degree, is a major headwind. Rising interest rates are raising the cost of both consumption and investment. Collectively, these headwinds will gradually drive earnings compression in the first through third quarters of 2023 and will likely drive continued market downside.

Looking forward, positioning for a tactical market buffeted by high volatility, raising interest rates and inflation requires adequate exposure to commodities, which benefit from inflation. Staples and pharmaceuticals with their defensive business models and rising dividends are also excellent sources of alpha. Once interest rates settle and charges relating to defaults moderate, financials exposure is a must. REITs round out the allocation required for the current market dynamic. 

Given the above and as mentioned in prior appearances, investors should revisit their risk management protocols and refine them where necessary. Prune poorly performing investments, consider taking profits on successful investments and raise cash. Investors should recognize risks are high and position accordingly. However, they should also be mindful that market sell-offs create excellent entry levels to lock-in long term core holdings at attractive prices. Perhaps most importantly, investors should be mindful of the phrase, you make money when you buy not when you sell.

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TOP PICKS:

Canadian Natural Resources (CNQ TSX)

1. A leading Canadian large-cap energy company focused primarily on western Canada.
2. Inexpensively priced across all valuation metrics.
3. A growing dividend currently yielding 4.50 per cent.
4. Shareholder-friendly governance supports 50 per cent of free cash flow allocated to debt reduction with the balance targeting share buybacks. Currently, buybacks effectively reduce one per cent of shares outstanding per month.
5. It has long-life reserves ~ 45 years. 

Open Text Corporation (OTEX TSX)

1. A growth by acquisition software integrator currently yielding three per cent.
2. The market is overly pessimistic on the Micro Focus acquisition given the lack of detail provided around the integration. However, post the acquisition closing on Jan. 31, further detail will be provided.
3. Significant insider share buying by prominent members of the board. 
4. Open Text is prone to periodic misses and subsequent selloffs. Buying on major declines has typically been a recipe for outsized performance.
5. It has grown revenue and net income over the 10-year period at an annual average rate of 14.2 per cent and 15.5 per cent, respectively. Similarly, the total return including the recent Micro Focus acquisition-induced sell-off averaged 13.4 per cent per year for ten years.

Medtronic PLC (MDT NYSE)

1. A dividend aristocrat, with 46 consecutive years of dividend increases, currently yields 3.4 per cent.
2. It’s the leading medtech pureplay.
3. Modest leverage going into the coming recession, which positions it for additional, accretive tuck-in acquisitions at attractive prices.
4. Medtronic is attractively priced.
5. Healthcare spending is typically resilient during recessions.  

PAST PICKS: February 11, 2022

Shell PLC (SHEL NYSE)

• Then: $55.21
• Now: $59.61
• Return: 8%
• Total Return: 12%

Walt Disney (DIS NYSE)

• Then: $149.47
• Now: $99.40
• Return: -33%
• Total Return: -33%

Visa (V NYSE)

• Then: $224.69
• Now: $223.06
• Return: -1%
• Total Return: -0.1%

Total Return Average: -7%