Darren Sissons' Top Picks: Sep. 11, 2018

Darren Sissons, vice-president and partner at Campbell, Lee & Ross
Focus: Global equities and technologies

MARKET OUTLOOK

The markets are clearly in flux and somewhat schizophrenic about the pricing of risk. They seem to have wholeheartedly adopted the thesis that the U.S. can do whatever it likes and the repercussions will be minimal. Places like Canada, China and the eurozone are perceived to have minimal defence against the Trump administration’s MAGA noise. Consequently, U.S. stocks are outperforming. But the logic supporting the outperformance is clearly flawed. 

China for example could begin selling off its enormous stock pile of U.S. debt instruments, which would put significant downward pressure on the U.S. dollar. It could also ring fence outbound capital repatriation (from the Argentinean playbook) for all U.S. companies. The latter strategy alone would punish major U.S. indexes, given the large Chinese revenue and earnings exposure for leading U.S. companies such as Procter & Gamble and through technology giants such as Apple. In the eurozone, leading American companies conduct significant volumes of domestic business while also exporting sizable dollar values to that market. Tariffs or a Fortress Europe revisit will negatively impact the U.S. Likewise here in Canada the cross border trade between the two countries tops $1 trillion. Even a small decline in trade volumes will negatively affect the U.S. economy and especially the northern states that do substantial business with Canada.

Another obvious risk mispricing is the defensive segments such as staples, telcos and utilities. These sectors are now significantly out of favour and offer high and generally sustainable dividend yields. Despite the real and valid concerns around rising interest rates, current bond yields are still well below the dividend yields offered by most defensive category companies. This yield differential will remain intact for a considerable period of time so investor aversion to defensive names is unwise and irrational.

Technology markets have started rolling over. The semicaps, which were driven largely by China’s domestic semiconductor industry ambitions, have rolled over. A broader, negative semiconductor contagion is now quite possible. Asian internet tech is stumbling and large cap U.S. tech be it hardware, semiconductor and semicaps or software will struggle under a strong U.S. dollar, as non U.S. demand will weaken moving forward if the MAGA noise continues. Remember: Technology is a high-beta market segment, so corrections can be quite vicious.

It’s been a tough year to be an emerging markets investor. Raising interest rate concerns and trade sanction threats have dealt heavy blows to emerging market currencies and valuation multiples. The emerging markets are experiencing a continual outflow of capital. While the pain isn’t yet over, we’re approaching levels that justify exposure to this segment. Yet, a word of caution: not all emerging market nations are created equal. Some nations are still highly investable now, while others will take a number of years to recover.

Given the above, investors should consider adding a defensive tilt to their portfolio if they haven’t already. A flight to quality where blue chips are favoured over small- and mid-cap stocks is likely warranted at present. Further, given the market corrections to date, investors should consider raising cash levels somewhat to enable opportunistic purchases of discounted high-quality securities.

TOP PICKS

HSBC HOLDINGS (HSBC.N)
Last purchased at $42.93.

1. A sustainable 5.9 per cent dividend yield.
2. A strong balance sheet.
3. HSBC, like other financials, will benefit from rising interest rates.
4. Banks and insurers have under-earned since the financial crisis due to a toxic combination of over-regulation and lower interest rates. Both of these pressures are now abating somewhat and forward-looking earnings should be better.
5. A balanced geographical exposure, as HSBC is effectively 40 per cent Europe (a mature market), 40 per cent Asia (a growth market) and the rest Latin American and others.
6. The Trump administration’s anti-trade MAGA agenda has provided an attractive entry level for new opportunistic investors.

NESTLE (NSRGY.PK)
Last purchased at CHF 78.57.

1. A sustainable growing dividend currently yielding 2.9 per cent.
2. A strong balance sheet.
3. The company has announced a number of acquisitions and deals in 2018, including the high-profile Starbucks joint venture.
4. Enviable historical performance metrics in Canadian dollars, as the dividend and total return has grown at an average of 9.9 per cent and 9 per cent respectively for 15 years.
5. Substantial unrecognized value, that is the L’Oreal holdings and the indirect Sanofi investment.

SUBSEA 7 (SUBCY.PK)
Last purchased at NOK 118.

1. A 4.5 per cent sustainable dividend yield.
2.  A strong balance sheet as the company has more cash than debt.
3. A highly technical barrier or competitive advantage (there’s only three market participants), as the company is an oil field services company with expertise at 300-feet below sea level and beyond.
4. The largest shareholder and chairman of the board, Kristian Siem, has a strong track-record of value creation in the offshore industry.
5. Offshore oil capex is gradually moving higher.

PAST PICKS: SEP. 11, 2017

ALIMENTATION COUCHE-TARD (ATDb.TO)

• Then: $60.31
• Now: $66.24
• Return: 10%
• Total return: 10%

BANK OF AMERICA (BAC.N)

• Then: $23.36
• Now: $30.85
• Return: 32%
• Total return: 34%

ROTORK PLC (RTOXY.PK)

• Then: £243.80
• Now: £327.60
• Return: 34%
• Total return: 37%

Total return average: 27%

NOTES

• Nestle ordinary shares can be purchased in the U.S. under the symbol: NSRGF.
• Subsea 7 ordinary shares can be purchased in the U.S. under the symbol ACGYF.

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