MARKET OUTLOOK:

Inflation and the monetary policy plans of the U.S. Federal Reserve continue to dominate the headlines. Inflation is rising around the world at a rate that hasn’t been seen for many decades and could stick around longer than initially expected.   

The Federal Reserve’s policy response to the COVID-19 pandemic was extremely aggressive and likely helped to prevent a depression. Going forward, the central bank is planning an abrupt transition from easing to tightening and this monetary policy “U-turn” has come as a major shock to the equity markets. 

In the end, it looks like the Federal Reserve over-estimated the amount of stimulus required to get through the pandemic and is sharply reversing course by announcing plans to shrink its balance sheet and increase interest rates.

On the positive side, the U.S. economy and employment picture are very strong. In addition, there are US$1.6 trillion in reverse repurchase agreements on the Federal Reserve’s balance sheet. The interest earned on these assets is five basis points per year and this program prevented money market rates from falling below 0 per cent. These assets are a significant percentage of the central bank’s total assets (~18 per cent) and could provide equity markets with a cushion as liquidity is quickly pulled from other parts of the financial markets.  

With exceptionally low nominal interest rates and negative real returns, investors holding cash and low-yielding fixed income securities risk a loss in purchasing power over time. 

While putting investment dollars to work in this uncertain environment can be challenging, equities still look like the most attractive asset class for investors. 

Going forward, I think that investors should remain well diversified and defensively positioned. Some sectors of the equity market that look to offer attractive value include select technology companies, growth-oriented utilities, and out-of-favor REITs.

TOP PICKS:

Yum China (YUMC NYSE)
Last bought at $47.15 on February 4, 2022 
Yum China is the largest restaurant operator in China. The company generates revenues through company-owned restaurants and from franchise fees. Yum China’s most well-known brands are KFC, Taco Bell, and Pizza Hut but their restaurant portfolio also includes several other well-known local brands and concepts. 

While some near-term headwinds associated with the pandemic persist, the company’s resilient business model, proven management team, and strong digital capabilities should allow it to continue growing sales and profits at an above average rate. 

The company has an exceptionally strong balance sheet (net cash of $4B or $9 per share) and a loyalty program with over 360-million members. The shares currently trade at around 19x adjusted forward earnings and have a dividend yield of 1.0 per cent.

Great-West Lifeco (GWO TSX)
Last bought at $40.20 on Feb. 3, 2022
Great-West is a financial services holding company focused on providing insurance, investment management, and retirement services. The company has a mature market focus and operates in Canada, the U.S., and Europe. 

Great-West generates most of its profits in Canada and Europe and has made a big acquisition push in the U.S. retirement services market over the last few years.

Going forward, I think management will do an excellent job generating accretive earnings per share growth and generating strong returns for shareholders. The shares currently trade at 10.6x forward earnings and have a dividend yield of 4.9 per cent.

Enghouse Systems (ENGH TSX)
Last bought at $41.90 on Feb. 3, 2022
Enghouse is an enterprise software company with a global presence. Last year, more than 90 per cent of revenues were generated outside of Canada. The company acquires and manages software for several vertical markets and has a diversified product suite. 

Management has done a tremendous job compounding capital through acquisitions and looks for a cash flow payback within 5-6 years while minimizing shareholder dilution. 

In December, the company reported Q4 results that underwhelmed the market as demand for its video conferencing product (Vidyo) returned to pre-pandemic levels.

In addition, Enghouse was less active on the acquisition front as higher valuations within the marketplace didn’t support their return objectives. 

Going forward, the company has a strong cash flow profile and a large amount of excess cash (net cash of ~$200MM or ~$3.60 per share) that can support several shareholder friendly actions. The shares are currently down around 14 per cent year-to-date and have an adjusted trailing free cash flow yield of 5.4 per cent.

PAST PICKS: January 8, 2021

Dollar Tree (DLTR NASD)

• Then: $112.97
• Now: $137.76
• Return: 22%
• Total Return: 22%

Enbridge (ENB TSX)

• Then: $42.38
• Now: $59.91
• Return: 25%
• Total Return: 35%

Brookfield Asset Management (BAM/A TSX)

• Then: $49.49
• Now: $71.87
• Return: 45%
• Total Return: 46%

Total Return Average: 34%