Dec 6, 2018

Cameron Hurst's Top Picks: Dec. 6, 2018

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Cameron Hurst

Cameron Hurst, chief investment officer at Equium Capital Management
Focus: U.S. equities

MARKET OUTLOOK:

Imagine yourself in 2019, reflecting back on the year that was 2018, and the thoroughly disenchanting experience we all had in the markets.Then recall it was a year characterized by rising interest rates (expected), declining Fed asset purchases (expected), recognition of an imminent hangover post-U.S. tax reductions (expected), a trade war between China and the U.S. (unexpected, but nothing should be with this White House), and the three-ring circus named Brexit (how else was that going to turn out?).

Notwithstanding the economic elixir of peak corporate margins and trough credit spreads, which combined can make anything look possible, you couldn’t possibly be surprised at the market performance of the past year. It was always going to be tricky if not downright treacherous. Hat tip to our research team for calling 2018 a year to be tactical all the way back in October 2017.

The trouble now is that objects in motion tend to stay in motion. Indeed, Newton unintentionally stumbled upon momentum investing back in the 17th century. With the benefit of hindsight and Newton’s first law of inertia, investors should be approaching 2019 with apprehension. Think of it this way; strong corporate profitability, positive global growth, low interest rates appear to great at first blush--but that’s not what’s in motion. Rates and credit spreads are rising while global growth is slowing and corporate profit growth appears to peak. So what’s actually in motion is not pointed in the direction that augers for a robust positive market experience in 2019.

It is paramount for investors to watch liquidity indicators because the global trend of liquidity removal is the primary cause of this correction. We firmly believe this correction to be cyclical in nature. When liquidity stops contracting, credit normalizes and financial conditions indicators stabilize, only then will it be time to load up for the next bull run in equities. Into 2019, prudence continues to favour caution.

TOP PICKS

HEALTH CARE SELECT SECTOR SPDR ETF (XLV.N)

We have been in pre-positioning mode for months now and as we continue to breach lower index levels, incremental exposure makes more sense in a defensive area like real estate, particularly owing to its modest pro-cyclical tilt versus other bond proxy sectors.
We prefer broad-basket sector ETFs exposure through XLRE over the industry standard Iast year rate owing to lower cost and preferential industry weightings towards secular growth themes, namely data centres, storage and towers.
Secular themes continue to support the sector, namely aging populations, lifestyle diseases or the obesity epidemic, worldwide hospital spending and emerging markets demand.
Large pharmaceuticals have recovered from the drug pricing concerns. The valuations remain at mid-end of historic range while at the start of a new product cycle. This should drive low-single-digit revenue growth and margin expansion.
Managed healthcare are benefitting from moderated cost trends, stable commercial pricing and increased Medicaid membership growth supporting margin expansion.
Medical equipment will continue to grow mid-single-digit sales supported by strong end markets. This is expected to continue with new product launches and increased adoption.
The 2020 presidential election may increase drug price and healthcare reform rhetoric. These will limit multiple expansions, though earnings are still expected to grow mid-to-high single digits.

REAL ESTATE SELECT SECTOR SPDR ETF (XLRE.N)

We have been in pre-positioning mode for months now and as we continue to breach lower index levels, incremental exposure makes more sense in a defensive area like real estate, particularly owing to its modest pro-cyclical tilt versus other bond proxy sectors.
We prefer broad basket sector ETFs exposure through XLRE over the industry standard last-year-rate owing to lower cost and preferential industry weightings towards secular growth themes, namely data centers, storage and towers.
“Growing slower” is good for REITs.
Trade war rhetoric is more significantly impacting equity volatility and economic indicators around the globe.
It now appears economic momentum could be slower in the 2018 and 2019 than expected, although still positive, which caps longer term interest rates and staves off cap rate compression from what we previously expected.
Secular growth in industrial (think fulfilment center for Amazon), healthcare and tech-centric REITs maintains growth in the group despite slower than expected macroeconomic tailwinds.
If we’re too optimistic and growth slows more precipitously, rate compression will support low cap rates in the sector for the early stages of the slowdown, allowing time for more defensive tactical repositioning.

ALERIAN MLP ETF (AMLP.N)

We are neutral on energy however we like the secular and cyclical tailwinds currently supporting master limited patnerships (MLP) in addition to the attractive 8.5 per cent dividend yield.
Technically, the relative performance of the group broke its downtrend this spring after a multi-year period of underperformance as excess capacity had been built up during the bull run in oil with the help of significant leverage.
We now view that unwind as largely complete and with continued global demand for oil and increased U.S. exports, U.S. pipeline capacity is now constrained (Permian likely through 2020) driving up volumes and giving pricing power back to the pipeline operators.
With a well supported 8.5 per cent dividend yield (more than offsetting the high cost of ownership), investors are being paid a significant yield for exposure to a group with improving fundamentals and growth opportunities.
Interest rates are a negative headwind, but we view hikes as being largely priced in at this point and expectations are at risk of being downgraded.
The recent energy transfer equity and energy transfer partners announcement yet more evidence that the sector is making headway at simplifying its structure and improving its balance sheet, which in turn should lead to better growth opportunities and less risk for investors.
In sum, we like the late cycle positioning as well as infrastructure set up for MLPs which should drive a growth cycle supporting their attractive yield.