Cameron Hurst's Top Picks: Feb. 6, 2019

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

MARKET OUTLOOK

Acknowledging the inconvenient reality that bounces are the most difficult markets to call, Equium Capital’s investment process relies upon a conservative approach of waiting for technical confirmation before adding exposure. The firm’s primary goal is capital preservation, which is most poorly served by buying dips. For example, the fourth quarter was littered with examples of buyers stepping in on a valuation argument only to suffer mightily under continued selling pressure. Unfortunately for retail and institutional investors alike, the fourth quarter sell-off was the inevitable manifestation of accumulating excesses and unsustainable bullish sentiment resulting from a long bull market run. In other words, it was very emotional.

Indeed, it wasn’t until the historically significant Christmas Eve sell-off that the market found its footing. Immediately following that decline, the advance/decline volume ratio made a multi-year high and put/call ratios finally spiked, all while short-term oscillators were at rock bottom oversold levels. Pairing this technical confirmation with a fundamental outlook which supported higher valuations, our process added significant equity exposure back into portfolios before the start of 2019.

From here, the bulls will note supportive conditional indicators, such as:

1. Coincident corporate spread tightening;
2. Improved U.S. financial conditions indexes;
3. An expansion in equity breadth, though not jaw-dropping in magnitude; and
4. 4 Sustained improvement in semis’ relative strength, which put in a double bottom back in October/November.

Accordingly, some 2019 outlooks lean towards the more optimistic view that the recent pronounced drawdown reflected a mid-cycle slowdown and healthy/overdue market pause. Fundamentally, this sanguine view of the recent market spasm is predicated heavily upon only modest economic deceleration with the Fed on hold for the foreseeable future. That said, the team at Equium Capital remains unconvinced and the wide dispersion of 2019 forecasts suggests significant room for surprise as the year progresses.

Aside from the pleasant relief of the rally and more balanced short-term trading indicators, we note at least as many medium-term negative indicators to be aware of. Relative strength measures of Asset Managers, Transports and Small Caps, historically good coincident confirming indicators, have yet to turn positive. Credit spreads, while better, are far from tights of a year ago. Global growth is on a sustained path of deceleration. And perhaps most at odds with a rosy outlook, U.S. Treasury yields are breaking lower, not higher.

The exact calculus underpinning market moves is always easiest to see in the rearview mirror. For now, we simply observe these indicators do not suggest the odds are in favour of sustained higher equities from here. The firm’s process added equity weight to increase a deeply underweight position in the last days of 2018, but portfolios remain underweight equities even with the added tactical exposure. With the balance of risks roughly neutral at present, we remain conservatively positioned and focused on wealth protection.

TOP PICKS

ISHARES U.S. MEDICAL DEVICES ETF (IHI)

• Stable mature end-market fundamentals while newer markets (diabetes and oncology) continue to maintain growth. Strong demand during an innovation cycle has offset pricing pressure and should continue to support double-digit revenue growth.
• The group exposed to positive secular trends: aging population, lifestyle diseases and the obesity epidemic and emerging market demand.
• IHI offers investors a defensive but still growth tilt. Channel checks demonstrate stable end-markets (cardio, diagnostics, surgical and tools) with respect to volumes and pricing.

ISHARES MSCI BRAZIL ETF (EWZ)

• Brazil is set to outperform both from a macro standpoint, due to U.S. dollar weakness and economic/interest rate convergence as well as on country-specific economic reforms to be implemented by President Jair Bolsonaro.
• On a technical front, after the weakness that plagued emerging markets over mid-2018, Brazil has been early to recover and has shown relative strength to both the broader market and emerging market peers.
• Emerging markets broadly are set to outperform on macro themes in 2019, stemming from a convergence in performance (after the stark outperformance of U.S. large-cap equities in 2018) and benefitting from an expected weaker U.S. dollar (attributed to a decrease in interest rates and growth differentials).

REAL ESTATE SELECT SECTOR SPDR ETF (XLRE)

• We maintain the market environment is more aligned with late-stage than mid-cycle timing and accordingly use real estate to balance portfolio risks, particularly on interest rates.
• If we’re wrong, incremental defensive exposure like real estate will work better in mid-cycle than other bond proxies, such as utilities, owing to its modest pro-cyclical tilt.
• We prefer broad-basket sector ETF exposure through XLRE over the industry-standard IYR owing to lower cost and preferential industry weightings towards secular growth themes, namely data centres, storage and towers.
• “Growing slower” is good for REITs: As economic momentum slows in 2019, assuming no recession, longer term interest rates should be capped, which reduces the risk of cap rate expansion/valuation compression. Secular growth in industrial (think fulfilment centres for ecommerce), health care and tech-centric REITs maintains growth in the group despite slower-than-expected macroeconomic tailwinds.