Jan 8, 2019

Cameron Hurst's Top Picks: Jan. 8, 2019

BNN Bloomberg

Cameron Hurst , BNN Bloomberg

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

MARKET OUTLOOK

We always harp on process and having a robust, risk-focused approach that’s intended to keep you out of trouble. Principally owing to the challenges we all faced in 2018 and our focus on capital preservation, it was hard to not come across as overly negative when callers asked about stocks that weren’t meeting our criteria, which was most of them.

The reason we’re so focused on not losing capital is the asymmetry of investment returns: if you lose 25 per cent you have to earn 33 per cent to get back to flat. It stands, then, that it’s better not to lose big in the first place and put yourself in a precarious position of needing to take more risk to stay afloat.

So while it’s difficult to sit on your hands at times, there are years when doing nothing is the best option. 2018 was one of those years in public markets and we think 2019 is looking fairly precarious as well.

There’s an incredible mean-reversion rally underway. In the last couple days of 2018 we bolted on tactical exposure, which is helping us participate to some extent, namely CAD-hedged S&P 500 exposure.

Positively, credit is confirming the snap-back, with 10-year yields rising and corporate credit spreads tightening coincidentally. For that and other reasons, we believe this rally could last more than a couple weeks (though our positioning always remains dependent on process and market developments).

Negatively, the underpinning economic data around the globe is slowing to multi-year lows as central banks continue to normalize monetary policy, creating substantial headwinds for corporate profit growth and broad-based deceleration, note the recent Apple and Samsung guidance.

We’re watching a litany of indicators on this bounce to monitor its strength and durability, but some of the easier to follow include relative performance of small caps, asset managers, semis and transports. Indexes reflecting financial conditions should also give confirmation of continued risk or clearing storm clouds. And lastly, investors should watch corporate credit spreads closely for when they stop tightening and the flatness of the yield curves.

On this last point of credit, we encourage investors to watch very closely developments in monetary policy, credit and liquidity. While numerous pundits and commentators continue talking about valuation both as a reason to buy stocks here and as justification that they shouldn’t have been sold in the first place, they’re flatly missing the point. Global markets have been inflated by unprecedented monetary stimulus. It can only stand to reason that as this monetary support is withdrawn and with it the incremental buyer of everything from Treasury bonds to high-yield debt to developed and emerging market equities, markets will struggle to make new highs.

Compounding the mechanics of this market, yield curves are telling us a recession is on the horizon, though possibly not as soon as this year. It’s a pretty standard script and history would tell you we have an average of 18 months from now until recession, but the wildcard is all the extraordinary policies and how that unwinds.

Bottom line, we are participating in the rally but remain underweight equities, neutral bonds and overweight cash (now that we finally earn more than 2 per cent on it). Acknowledging that this could be another tactical year, we’re proceeding with caution.

TOP PICKS

HEALTH CARE SELECT SECTOR SPDR ETF (XLV)

The healthcare sector has components that excel in both strong and weak markets. This ETFs’ largest weight, pharmaceuticals, has a defensive quality with stable earnings visibility, while the medical equipment component has a quality growth tilt. The current valuation of forward price-to-earnings (P/E) at 15.4 times earnings remains in the middle of historic range.

ALERIAN MLP ETF (AMLP)

We’re neutral on energy, but we like the secular and cyclical tailwinds currently supporting MLPs 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 (in the Permian likely through 2020), driving up volumes and giving pricing power back to the pipeline operators.

We like the late-cycle positioning as well as the infrastructure set up for MLPs, which should drive a growth cycle supporting their attractive yield.

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. On a country-specific basis, we like the economic reforms set to be implemented by the incoming 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. Key upcoming catalysts will primarily be the ability to pass meaningful pensions reform through a split congress and reducing the debt load, which amounted to 78 per cent of GDP in 2018.