Shane Obata, portfolio manager, Middlefield Capital

FOCUS: Global and North American large caps 

MARKET OUTLOOK:

After a strong start to the year, North American equity markets gave back some of the early gains in February with the S&P 500 and TSX Composite Index each returning -2.5 per cent. Growth stocks continued to outperform, highlighted by the NASDAQ declining just one per cent and still up nearly 10 per cent year-to-date. European equities fared much better in February with most indices generating positive returns.

Notwithstanding the likelihood of a “higher-for-longer” interest rate environment, we are encouraged by the overall health of the economy. Consensus 2023 U.S. gross domestic product growth forecasts have risen from 0.3 per cent to 0.7 per cent recently and the Atlanta Federal Reserve’s GDPNow model points to 2.8 per cent growth in the first quarter. The Bureau of Labor Statistics reported that the number of job openings increased to 11 million in December while the unemployment rate is at its lowest level since 1969.

Other recent data showed Americans increased spending at retailers and restaurants in January by the most in nearly two years. While higher interest rates pose a risk to equity valuations and sentiment, a hard-landing recession would likely be much worse for the stock market. We believe the probability of this scenario occurring has fallen in recent weeks and are optimistic that a soft, or even no-landing scenario will play out.

We remain focused on companies that can navigate higher rates in the near term. Companies with exposure to floating rate debt or substantial upcoming debt maturities will likely face higher interest costs which will weigh on margins. We also favour companies with strong pricing power that can pass through cost inflation to their customers.

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TOP PICKS:

Sony (SONY NYSE)

Purchased at $87.27 USD on March 8, 23

One of our preferred names in the discretionary sector. Sony (SONY) has a leading portfolio of assets across gaming, music, movies and entertainment. In the gaming business, PlayStation 5 penetration is accelerating as supply chain constraints ease. This bodes well for software sales as well as PS Plus subscriber numbers.

In music, Sony is one of the three dominant players, alongside Universal and Warner. All three have benefited tremendously from the secular rise of streaming. In pictures, Sony holds franchises such as Spider-Man but the real upside may come from IP synergies as we saw with Last of Us. At the group level, profitability (e.g. ROIC) has been under pressure but should return and recover gradually as the company slows its pace of investment. Sony trades at a forward P/E of ~16x, which we think is reasonable given the potential for high-single-digit EPS growth over the next few years.

Enphase Energy (ENPH NASD)

Purchased at $210.87 USD on March 13, 23

One of our top picks in the clean tech industry. Enphase (ENPH) is a leading player in the market for solar inverts, which are used to convert direct current produced by solar panels into alternative current that can be used in homes. ENPH’s microinverters, called Module-Level Power Electronics or MLPEs, are more efficient, flexible and reliable than string inverters. As a result, we expect MLPE share gains to continue. In addition to benefitting from industry tailwinds, Enphase also provides energy storage and EV charging solutions. While ENPH’s margins are already attractive, we believe they will get better as the company introduces new products and continues to move from components to systems (e.g. inverters, batteries and software). With a forward P/E of ~40x, it looks expensive at first glance. Even so, we believe the current valuation is reasonable given the company will likely grow earnings at 30 per cent+ over the next three years.

Brookfield Asset Management (BAM TSX)

Purchased at 42.71 CAD on March 13, 2023

Following the Spin, Brookfield Asset Management (BAM) provides nearly full exposure to fee-related earnings, which are the most important driver of valuations for alternative asset managers. BAM is highly exposed to infrastructure and renewables as well as credit, both of which should perform relatively well in an environment with inflationary pressures. Brookfield is currently in the market for various flagship funds and is expected to launch multiple new products over the next two years. While the company maintains significant exposure to real estate, we would note that they have been fundraising and are left with tens of billions to deploy into devalued assets. While BAM trades at >20x on a P/FRE multiple, after incorporating for growth we are left with a PEG ratio of ~1.1x, which is one of the lowest in the industry. 

PAST PICKS: May 6, 2022

Advanced Micro Devices (AMD NASD)

• Then: $95.34
• Now: $86.45
• Return: -9%
• Total Return: -9%

Blackstone (BX NYSE)

• Then: $101.49
• Now: $85.65
• Return: -16%
• Total Return: -13%

Amazon (AMZN NASD)

• Then: $2,295.45
• Now: $93.39 (After 20-for-1 stock split on June 6th 2022)
• Return: -19%
• Total Return: -19%

Total Return Average: -14%