Teal Linde, manager, Linde Equity Fund

FOCUS: North American mid and large-cap stocks 

MARKET OUTLOOK:

This year has been the year of large-cap tech, namely the magnificent seven, which is essentially a rebrand of the former FAANG stocks. After plummeting in 2022, these stocks have roared back in 2023 with individual year-to-date gains spanning from 50 to 230 per cent. With these seven stocks representing around 30 per cent of the S&P 500 market capitalization, movements can drive the direction of the entire index. These seven stocks tend to be much more volatile because they are all on the Nasdaq Composite.

Nasdaq stocks typically trade at lofty valuations, so valuation risk is increasingly at play as these Nasdaq stocks become such a large portion of the S&P 500.  As an illustration of how far these stocks have risen, up until the end of 2021, the Nasdaq had quadrupled in a span of six years. It got ahead of itself. Then when the Nasdaq fell by about 30 per cent in 2022, the total gain became a triple over seven years, still high at a 16 per cent compound annual growth rate (CAGR). Yet despite still being up three times and overall expensive, the Nasdaq 100 has nearly shot right back up in 2023 to its 2021 highs, resulting in a four-times return over the last eight years.

The speculative and momentum excesses from the pandemic era have returned, largely because there was no capitulation in 2022 to inflict enough pain to turn people off stocks. People didn’t get sufficiently burned. Animal spirits within the market remain alive and well. Therefore, if a soft landing arrives, large-cap tech will unlikely be the source of future large gains. They’ve had their run. Greater opportunity will likely be among the 493 other stocks in the S&P 500 that have yet to recover. 

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TOP PICKS:

LINAMAR (LNR TSX)

Linamar, as a company, is doing alright overall, largely because its industrial segment, which includes its Skyjack aerial lift business, and its agriculture machinery business, is doing very well. The results of its industrial segment are actually masking its underperforming auto parts business. But here's the opportunity, its largest industrial business, Skyjack, is expected to continue to perform well next year because its entire industry is still enjoying high backlog levels. Furthermore, Skyjack's two main competitors, Oshkosh and Terex, have both said prices may rise next year due to rising costs. However, Linamar has stated it will not need to raise its prices and is optimistic about taking market share as a result, likely because its manufacturing is domiciled in Canada where it can take advantage of the weaker Canadian dollar. So, if the auto parts business, which is their largest business, can improve profitability from low levels to just average levels next year, a noticeable lift in earnings could occur to support a higher share price.

TC ENERGY (TRP TSX)

TC Energy's outlook over the next 12 months is looking attractive on a risk-adjusted basis. There are a few reasons for this. First, the company recently increased financial guidance for the current year, from EBITDA profit growth range of five to seven per cent up to eight per cent. Second, the company is confident in its line of sight to reduce its debt load to a more a respectable 4.75x debt/EBITDA. Third, with the company's dividend currently yielding 7.2 per cent, management reiterated their annual dividend growth of three to five per cent, which means a total return of 10 per cent to 12 per cent. Finally, Canada's economy appears to be heading or is already in a recession, which could prompt the central banks to start reducing interest rates, which would likely place upward pressure on dividend-paying stocks like TC Energy.  

TD BANK (TD TSX)

 The Canadian banking sector is finally starting to look a bit better. Based on the sector’s latest quarter, margins are stabilizing and modest expansion is anticipated next year as the banks are expected to achieve higher reinvestment yields on securities investments that are maturing. Its funding mix is starting to stabilize as the fleeing of deposits from low-interest-rate accounts is abating. Also, every bank has recorded restructuring charges in the last quarter, which for the banks, is their last quarter of the fiscal year. So they like to write off whatever they can in the last quarter to set the stage for a cleaner new fiscal year. But the only bank that didn't do this is TD Bank. TD recorded charges, but it was the only bank that also said they expect to record charges in the upcoming year in order to strengthen its risk management and AML controls in its U.S. operations. So, TD didn't enjoy a jump in share price like other banks did over the last month. But within 12 months, these additional charges ought to be in the rearview mirror allowing TD's stock to catch up with its peer group.