John Zechner, chairman and founder of J. Zechner Associates

FOCUS: North American large cap stocks

MARKET OUTLOOK:

The U.S. Federal Reserve’s ‘pivot’ in interest rate outlook at the end of October last year was the catalyst for a six-month rally in stocks and an ever-larger initial gain in bonds, where the 10-year yield fell from 5.0 per cent to 3.8 per cent. At that time, the Fed ‘dot plot’ forecast three interest rate cuts in 2004. Investors were even more bullish, looking at as many as six cuts, starting in March. 

Stubbornly high inflation and resilient economic growth lead to the slow retraction of these bullish interest rate forecasts. That, in turn, took its toll on the bond market, which retraced almost all those sharp gains as the 10-year yield climbed back up to 4.7 per cent. Stocks continued to rally despite the rate backup as investors shifted to cyclical sectors, such as energy, financial and industrials, on optimism about ongoing strength in the U.S. economy. But, with stock valuations and bullish sentiment near record levels, the reality of more muted expectations on interest rate cuts and meagre earnings growth, outside of the tech sector, ground the rally to a halt in the past month. Upside momentum is challenged in the short term.

We remain slightly underweight on stocks but have added to bond holdings in the past week as we expect inflation to fall further towards central bank targets and economic growth to slow down in the back half of the year. The U.S. has been the global economic leader, but much of that had to do with the massive fiscal spending and the wealth effect on spending from strong capital markets. The U.S. has also been more immune from the aggressive interest rate increases of the past two years due to the long-term nature of most consumer and corporate debt. Those tailwinds are fading, and the U.S. will see growth slow down much like we have seen in Canada, Europe, Japan and the emerging markets. 

With this muted outlook, we find better risk-reward trade-offs in the defensive and interest-sensitive sectors such as telecom, utilities, pipelines, energy and gold. Within tech, we maintain a market weight position but have switched funds away from semiconductors to software and services, which we believe will be the bigger long-term beneficiaries of the growth in AI, rather than the infrastructure builders, which have been the biggest winners thus far. The massive capex plans of Microsoft, Alphabet and Meta all show that the rollout of AI for the hyper-scalers will support further growth and expand to more corporate users to improve productivity.  The risk that keeps us from overweight tech right now is that we are not convinced that these companies can ‘monetize’ their AI investments as quickly as investors currently expect.

TOP PICKS:

Meta Platforms (META NASD) 

Meta Platforms builds technology that helps people connect and share, find communities, and grow businesses. The company’s products enable people to connect and share with friends and family through mobile devices, personal computers and devices. It operates through two segments: Family of Apps (FoA) and Reality Labs (RL). The stock has rallied sharply in the past 18 months, but still trades below a market multiple despite excellent exposure to the rollout of AI services. Its mobile advertising business is recognized as one of the best targeted methods of reaching customers and has driven tremendous growth. We see opportunity in the stock, which sold off recently on investor concern about the wisdom of continued spending on Reality Labs.

Rogers Communications (RCI.B -TSX) 

Rogers and all the telecom stocks have traded lower over the past two years as worries about increased competition in wireless, less student immigration to maintain subscriber growth and a general avoidance of the interest-sensitive sector of the market due to sharply higher interest rates. The fundamentals of the company continue to improve though with strong wireless results and the ‘bundling’ of phone, wireless, internet, TV and home security all helping to solidify the customer experience. Streaming also adds to the demand for their services, which have proved resilient in all economic scenarios. The stock trades at only six times forward operating cash flow, generates strong free cash flow and continues to grow.

Pfizer (PFE NYSE)   

Pfizer stock has fallen more than 60 per cent from its 2022 high as a drop in COVID-19 vaccines has reduced revenues and earnings, but the company has done a great job of using the ‘windfall’ of vaccine revenues to add to its pipeline of growth including promising diabetes and cancer drugs. The FDA also granted full approval to Pfizer’s COVID-19 antiviral pill Paxlovid for adults who are at high risk of getting severely sick with the virus. The stock has a dividend yield of more than six per cent, trades at less than 12 times earnings and should have annual earnings growth of more than 12 per cent over the next five years.

PAST PICKS: April 6, 2023

PayPal Holdings (PYPL NASD)  

• Then: US$74.96
• Now: US$67.17
• Return: -10 per cent
• Total Return: -10 per cent

MDA (MDA TSX)  

• Then: $6.91
• Now: $14.70
• Return: 113 per cent
• Total Return: 113 per cent

BRP (DOO TSX)  

• Then: $97.37
• Now: $94.33
• Return: -3 per cent
• Total Return: -2 per cent

Total Return Average: 34 per cent