Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

Markets over the past month are bouncing amidst an ongoing cyclical downturn that began nearly a year ago for the leading technology stocks and broadened out into the rest of the market this past winter. With the political theatre of midterm elections now in the rear-view mirror and the last hurrahs of a fairly decent third-quarter earnings season soon ending, November could prove to be a more challenging month for equity investors than October was. But then December ushers in the most consistently positive month for stocks – the well-known and touted Santa Claus rally. 

Our portfolios remain cautiously positioned, with higher-than-normal cash balances, sizable holdings of very defensive consumer staples and health-care companies. Also, our portfolios are positioned with relatively little exposure to the resource sector (ex. gold) or long-duration and interest-rate-sensitive sectors like real estate. Inflation is public enemy number one and the ongoing rate hike campaign across most of the developed world will bring it to heel – by choking off excess demand. Stocks discount this slowing growth relatively quickly and thus turned down well ahead of the economy. The real economy is also affected by monetary policy, but with a long and variable lag. This lag is often thought to be 12-18 months. Indicating that the first of the U.S. Federal Reserve and the Bank of Canada’s rate hikes have barely even begun to weigh on economic output, let alone the most recent rate hikes in this ongoing campaign.

In 2023 we expect to see job losses, lower corporate profits, higher bank credit loss provisions and lower corporate and consumer confidence. This is measured both by downbeat surveys and waning “big ticket” activity like mergers and acquisitions in the corporate world and fewer home and auto purchases in the consumer world. We do expect to see conditions falling into place for a durable cyclical upturn in the markets, rather than simply a bounce in the ongoing bear market sometime during the middle part of 2023. However, the real economy still needs to take a few steps backwards before the stock markets can take their next big steps forward. 

We are monitoring and measuring 39 different cross-asset class metrics to assess when that transition is nearing completion. When it does, we will shift portfolios back towards a more aggressive posture to capture the historically outsize gains in the early stages of a new cyclical bull market deliver.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

TOP PICKS:

Tractor Supply (TSCO NASD)

Latest purchase November 2022 at $212.73

Tractor Supply is a ubiquitous presence in rural America, operating over 2,000 farm supply and rural lifestyle stores across 49 states. Its core customer in many cases is a farmer, horse owner, rancher, hobby farmer or simply an exurban or rural homeowner. The common denominator is that the customer tends to have above-average income and below-average cost of living. 

The stores sell pet and livestock supplies, hardware, tools and truck supplies; as well as toys, apparel, seasonal merchandise and maintenance products for agriculture. Tractor Supply targets between six and seven per cent annual sales growth, with between four and five per cent same-store sales growth supplemented by new store openings. 

The company has grown dividends at a 25 per cent compound rate over the past decade and currently sports a yield of just under two per cent. The company has a strong and sustainable competitive advantage as a differentiated, experiential retailer operating in less contested regions and categories and accordingly has performed well during tough economic times, with the shares outperforming market indices in five of the last six major bear market cycles.

Franco-Nevada (FNV TSX)

Latest purchase February 2022 at $189.97: 

Franco-Nevada is a resource royalty and investment company whose management team and founders pioneered the resource royalty concept 40 years ago. The business model affords shareholders exposure to commodity prices through a royalty payment for each ounce produced. This is primarily, gold, silver, other precious metals and to a lesser extent, oil, gas and other metals. This insulates it from the operating and capital cost overruns that are endemic to the mining industry. The business model also affords shareholders long-term optionality on future discoveries on any of its royalty lands, across a portfolio of 416 royalties that is well diversified by commodity, geography and operator. Franco-Nevada has consistently and significantly outperformed its gold mining peer group, in 11 of the last 14 years since its initial public offering, on the strength of this superior business model.

Brookfield Asset Management (BAM.A TSX)

Latest purchase May 2022 at $61.39

Brookfield is among the world’s foremost managers and operators of long-duration real assets like real estate, private equity, infrastructure, renewable energy and utilities with deep expertise in sourcing transactions and surfacing value. The company has tremendous reach and geographic diversity with significant assets in Canada, the U.S., the U.K., Australia, Brazil, India and more.

Brookfield’s size and scale allow it to field expert teams with deep operating experience across industry verticals and geographic areas. Moreover, its financial strength and variety of funding sources afford it the advantage of being among the first calls that sellers of world-class assets make when looking to consummate a transaction. Flows into alternative assets are outstripping flows into stocks and bonds, as institutions like pension funds increase allocations to these less efficient markets which better match its long-duration liabilities. Accordingly, Brookfield enjoys consistently strong inflows and now manages over $750 billion. The company has generated a compound annual return for shareholders of 16 per cent over the last 20 years, such that one dollar invested in its shares is now worth over $20, courtesy of these many structural advantages. 

PAST PICKS: November 3, 2021

Intact Financial (IFC TSX)

• Then: $165.34
• Now: $198.15
• Return: 20%
• Total Return: 22%

Methanex (MX TSX)

• Then: $57.62
• Now: $50.52
• Return: -12%
• Total Return: -11%

Royal Bank of Canada (RY TSX)

• Then: $132.17
• Now: $128.92
• Return: -2%
• Total Return: 1%

Total Return Average: 4%