John Zechner, chairman and founder, J. Zechner Associates

FOCUS: North American large-cap stocks 

MARKET OUTLOOK:

Financial market troubles of the past two years continued from September to October, despite heading into what is typically the strongest period of the year for stocks. We have maintained a defensive posture in our managed accounts. We continue to expect some reprieve in stocks before year-end as valuations have become more attractive and interest rates have peaked, so we started to add to our very low stock weight in anticipation of some recovery. 

However, stocks still face a tough earnings landscape as profits continue to come under pressure from higher input costs and weaker economic growth. The biggest risk for stocks right now is earnings expectations and the guidance for the next few quarters as economic growth slows further. The consensus on S&P 500 Index still expects 12 per cent profit growth in 2024 over 2023. That seems far too optimistic. We expect much weaker growth over the next few quarters and probably a recession so we don’t see these earnings estimates as achievable.

Bonds on the other hand look like an exceptionally good buy in the current environment. We continue to add to our fixed-income holdings, particularly in the U.S. using the cash reserves in accounts. Bonds are looking like one of the more attractive risk-return trade-offs we have seen in financial markets since early in the pandemic, even after the rally last week. On stocks, our focus continues to be on sectors with good dividend yield support and/or earnings less aligned with economic cycles. Pipelines and telecom stocks meet both criteria. We have also added to technology stocks on recent weakness since their earnings growth is less cyclical, supported by increasing penetration of cloud services and AI as productivity enhancement tools. They are also “long-duration” assets and should therefore benefit more from an expected peak and subsequent decline in interest rates. Finally, valuation following the recent pullback is also less of an issue and tech should retain premium valuations due to stronger long-term growth than cyclical sectors.

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TOP PICKS:

PayPal Holdings (PYPL NASD) 

Latest purchase US$54 – November 2023    

PayPal is a technology platform that enables digital payments that connect merchants and consumers with over 400 million active accounts across more than 200 markets. Its brands include PayPal, Braintree and Venmo among others. It is a great play on electronics payments growth, generates strong free cash flow and trades at under 12 times forward earnings. Moreover, new management has a renewed focus on profitability under multiple payment umbrellas. The massive selloff in the payments sector over the last two years has created a great risk-reward tradeoff in the stock.

Pembina Pipeline (PPL TSX)  

Latest purchase $41 – August 2023   

We believe that energy infrastructure stocks in Canada present a good long-term growth opportunity. This is because lower-cost oil and gas needs to be moved from the major production fields in Alberta and B.C. to the rest of Canada as well as the U.S. and international markets from the western ports. LNG will also provide a new growth market for Canadian products. Pembina trades at only ten times its operating cash flow, is well-financed, has capital growth projects and a fully covered dividend yield of over six per cent.

Martinrea International (MRE TSX)  

Latest purchase $11.50 – Sept.  2023   

Despite an expectation of slower economic growth and reduced consumer spending, the auto parts stocks are already reflecting recessionary conditions in current valuations. Moreover, as results from Magna last week showed, the parts companies see margins holding firm and increasing penetration in both ICE as well as electric vehicles. Martinrea has established itself as a major player in the “lightweight” of autos by increasing wins for their aluminum parts. 

PAST PICKS:

MDA Ltd. (MDA TSX)

• Then: $6.40
• Now: $11.66
• Return: 82%
• Total Return: 82%

Rogers Communications (RCI.B TSX)

• Then: $63.37
• Now: $55.48
• Return: -12%
• Total Return: -10%

Alphabet (GOOG NASD)

• Then: US$88.73
• Now: US$131.91
• Return: 49%
• Total Return: 49%

Total Return Average: 40%