Darren Sissons' Top Picks: Jan. 31, 2018

Darren Sissons, vice-president and partner at Campbell, Lee & Ross
FOCUS: global equities and technology

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MARKET OUTLOOK

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness,” Dickens wrote in A Tale of Two Cities. This phrase is apt for describing the current markets. In some market pockets, such as the cryptocurrency and marijuana sectors, valuations are extremely elevated. Others such as high dividend-paying, low growth sectors like telcos, pipelines, consumer staples and consumer discretionary are under pressure with bargains beginning to appear.

The markets are in their typical first-quarter ascent as fresh capital flows into RRSPs and RESPs here in Canada and with inflows into 401K program in the U.S. It’s then hardly a surprise to see markets driven higher in the first quarter. However, spring and summer generally provide better entry levels. Patient, long-term investors should consider sitting on excess cash until April 1.

Some interesting and relatively widely held opinions currently circulating, which are at odds with underlying reality, include:

• The U.S. dollar is in structural and secular decline. In reality, the strength and weakness of the greenback in the last 12 months was largely driven by the mismatch between U.S. and Canadian interest rate rises. The current strength of the loonie, as we also saw in 2017, will last until the U.S. Federal Reserve raises interest rates again. Same logic applies to other currencies vis-à-vis the U.S dollar.
• Telcos, pipelines, consumer staples and consumer discretionary are now inferior investments.  For fresh capital, the yields in these sectors are now actually becoming increasingly attractive. The broader issue is these segments have been over-owned since the global financial crisis and the recent underperformance is skewing their longer-term performance.  For fresh capital, these segments offer an attractive risk-adjusted total return looking forward, in addition to protection against market corrections.
• The real estate bubble is a Toronto, Montreal and Vancouver issue largely driven by foreign buyers. Again, not correct. The primary driver of global real estate bubbles are low interest rates. Most OECD countries have real estate bubbles, including the following cities: Auckland, Tier-1 Chinese cities, Hong Kong, London, Paris, Singapore, Sydney, Taipei, Toronto and Vancouver. Equally so, a bubble has also appeared in corporate, industrial and multi-tenant residential housing in most major cities of wealthy and near-wealthy countries.
• Higher interest rates are a Canadian benefit or issues. Also not correct. A globally coordinated increase in interest rates is now playing out. Rising rates and pressure to raise rates are being seen in Canada, Europe (with some countries having stopped using negative rates) and the U.S., with many other nations actively guiding to higher interest rates moving forward.        
• Higher interest rates are good for financials. Financials are probably the most over-owned investment category now. Broad enthusiasm for the sector maybe somewhat disappointed as substantially higher dividends, which will ultimately drive the share prices of the sector, may take a while yet to appear. Further, higher interest rates will expose financial institutions to increased default risk as their clients face the challenge of debt repayment at higher interest rates.

Given the above, the post-financial-crisis easy money has now largely been made. Skill at asset picking, sector rotation and managing higher interest rates that detrimentally affect fixed income portfolios will increasingly become core competencies in the next few years. Positioning for and against foreign exchange rate moves will also be a key skill. Cash has option value and prudent investors should keep a cash reserve for opportunities that arise as the market rotation theme progresses.

TOP PICKS

AIR LIQUIDE (AI EPA)

1. ell-managed French multinational offering global exposure to the industrial gases market, which tracks global GDP.
2. Dividend currently yields 2.2 per cent and has grown at an average of 8.1 per cent in Canadian dollars for 15 years.
3. In the last three years the company has built a number of projects. These projects are expected to come online this calendar year and drive increased free cash flow, higher earnings and probably a higher dividend.
4. In 2016 the company acquired a sizable U.S. competitor, AirGas. The stock fell immediately on debt concerns, but has since recovered as synergies have been realized and debt levels have declined.
5. Air Liquide has a defensive business model that benefits from a high degree of predictable, recurring revenue.
6. In Canadian dollars the company has averaged a total return of 10.8 per cent for 15 years.

TD BANK (TD.TO)

1. It has an attractive growing dividend currently yielding 3.2 per cent.
2. TD is approximately 50 per cent Canada and 50 per cent U.S.
3. It has a solid, well-performing wealth management business.
4. Like all financials, TD will benefit from rising interest rates so revenue, earnings and dividends per share should move higher looking forward.
5. Fortunately, the company was not deemed a “too big to fail” global bank. Consequently, regulations on balance sheet strength, its commercial activities and its ability to grow its dividend will experience less regulatory oversight than RBC and the other systematically exposed global banks.
6. The bank has averaged a 12-per-cent total return per annum over the last 15 years.

SGS SA (SGSN VTX)

1. Well-managed Swiss company active in the Industrial Test segment, which is tied to global GDP.
2. Dividend currently yields 2.9 per cent and has grown at an average of 18 per cent for 15 years.
3. It has a strong balance sheet.
4. The tuck-in acquisition strategy consistently delivers accretive growth given the fragmented nature of the industry and SGS’s clear market leadership.
5. The company underperformed over the 2013-2015 period due to its energy and commodities exposure, but with the outlook for those markets now improving somewhat the prospects for SGS are better.
6. SGS has a resilient business model, which has a history of generated accretive financial metrics including: revenue, net income and dividends average annual growth of 7.8 per cent, 11.4 per cent and 18 per cent, respectively over 15 years.

    

   DISCLOSURE	PERSONAL	FAMILY	PORTFOLIO/FUND
   AIR LIQUIDE	Y	N	Y
   TD	N	N	Y
   SGS SA	Y	Y	Y

    

PAST PICKS: JANUARY 27, 2017

VISA (V.N)

• Then: $83.77
• Now: $124.08
• Return: 48.11%
• Total return: 49.16%

NOVO NORDISK (NVO.N)

• Then: $35.78
• Now: $56.01
• Return: 56.54%
• Total return: 61.37%

CSX CORP (CSX.O)

• Then: $48.06
• Now: $56.86
• Return: 18.31%
• Total return: 20.10%