Michael Sprung, president, Sprung Investment Management

FOCUS: Canadian large-cap stocks 

MARKET OUTLOOK:

It has been one year since the U.S. Federal Reserve started to raise interest rates in order to stem the inflationary forces that were becoming all too evident. Over the past year, global interest rates have increased as many of the other central banks followed the Fed’s lead. These actions have precipitated changes in the valuation metrics within the capital markets resulting in downward pressure on stock and bond prices. Concerns regarding slowing economic growth and even the possibility of a recession have driven many investors to the sidelines. Interest costs have risen dramatically following a binge of debt accumulation in the business, government and private sectors during the period of cheap money while inflation drives up prices for goods and services.

In this environment, markets will continue to be volatile and overcompensating in either direction depending on the nature of the news. Last week, three U.S. regional banks got into trouble with funding pressures and withdrawals. The Fed backstop facilities injected some US$164.8 billion in order to relieve some of the panic that ensued. In Europe, one of the larger banks, Credit Suisse, was bailed out by the Swiss government with the equivalent of US$54.6 billion and ultimately sold to UBS for US$3.25 billion, a fraction of its valuation years ago. We are likely to see more failures in more industries in the coming months. Financial stocks sold off substantially as events unfolded.

In this calamity, many opportunities for astute, long-term investors will arise. Authorities have already signalled that moral hazard will be expounded as it is perceived that the risk of creating panic outweighs the risk of bailing out larger firms embodying great systemic risk. While there are bound to be a number of failures, those companies with sound balance sheets and risk control will survive and profit. As inflation is brought to heel, interest rates will likely stabilize at levels higher than the past 10 years, but the business cycle will rebound and along with it, many of the securities that have been depressed.

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TOP PICKS

Bank of Nova Scotia (BNS TSX)

Last Purchase December 2022 $68.42

The Bank of Nova Scotia is the fourth largest bank in Canada by market capitalization. Recent turmoil in the financial world has put pressure on bank valuations as a result of higher interest rates and the recent failures of three banks in the United States and Credit Suisse which at one time was a major bank in a global context. The Canadian banks are well-capitalized and subject to close monitoring by regulatory agencies. Scott Thomas, the new chief executive officer for BNS, has stated that the bank is going to undergo a strategic review of its capital allocation priorities that should lead to higher profitability in various business lines. At current prices, the stock is trading close to book value and yielding around 6.3 per cent.

Telus (T TSX)

Last Purchase June 2019 $48.58

Telus is one of Canada's largest telecommunications companies. In addition to telecommunications, the company has established a strong foothold in healthcare IT, as well as offerings in Telus Health, Telus International and Telus Agriculture and Consumer Goods. After several years of heavy investment, Telus will begin to reap the benefits as FTTH (Fibre to the Home) and the 5G networks near completion. As free cash flow increases, dividends should also increase in the five to 10 per cent range over the next few years. At current levels, the stock yields an attractive 5.2 per cent.

CAE Inc. (CAE TSX)

Last Purchase, Last purchase March 2016 at $15.00

CAE is a world leader in the design and production of flight simulation systems used in commercial and military applications. The company also provides training services to civil and military customers globally.  Civil aviation will benefit as air traffic recovers from depressed pandemic levels. Training services outsourced by airlines will also accelerate growth going forward as pilot shortages are addressed and training on newer and/or modified planes is required. The current global tensions would suggest that defence contracting will also increase. While a smaller division, orders in healthcare have been robust. Margins and free cash flow are expected to increase as supply chain and labour issues abate over the next few years.

PAST PICKS: March 18, 2022

Sun Life Financial (SLF TSX)

• Then: $70.18
• Now: $62.67
• Return: -11%
• Total Return: -7%

Suncor Energy (SU TSX)

• Then: $39.12
• Now: $41.55
• Return: 6%
• Total Return: 11%

Enbridge (ENB TSX)

• Then: $56.46
• Now: $50.89
• Return: -10%
• Total Return: -4%

Total Return Average: 0%