David Driscoll, president and chief executive officer, Liberty International Investment Management

FOCUS: Global stocks

MARKET OUTLOOK:

After a two per cent to five per cent drop in global stock markets in September, we enter October with lots of questions. Among them are:

• Is unemployment rising or falling?
• Is inflation transitory?
• Is more bad news coming from China?
• Will corporate profits continue to rise at the 25 per cent rate that analysts have forecast?
• Is the stock market undergoing a small correction or are there greater storm clouds on the horizon?

The last time the Federal Reserve raised rates by 0.25 per cent was in the fall of 2018. Between Oct. 1 and Dec. 26, the S&P 500 Index fell 15 per cent. The FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) fell an average 25 per cent. If rates rise, tech stocks are vulnerable because they need cheap borrowing costs to offset their high cash burn rates. And if earnings disappoint in conjunction with a rate increase, we could we could face a Price-Earnings multiple contraction and get a deeper correction than anticipated.

That said, late October/early November is the time of year when I like to buy stocks. That’s because markets are often weakest and the fourth quarter tends be the best of the four in terms of profit reports. The next upward climb in the stock markets will rest on earnings growth and the direction of interest rates.

For investors, it’s important to take profits on stocks that have doubled in the last year as they are most exposed to a correction. Also, be diversified as it is a very risky time to have a lot of correlated stocks in your portfolio. And if you have cash to buy, focus on the ones that make up the lowest percentage weighting in your portfolio. They have the best chance of going higher.

TOP PICKS:

Logitech International (LOGN SWX) – last purchase was Aug. 6 at 99.84 CHF

Makes computer mice, trackballs, game controllers, keyboards, video cameras and multimedia speakers. Sales have fallen because of the COVID-19 lockdowns (except on the video conferencing equipment side) so a higher price move will depend on a re-opening of the economy. Meantime, the dividend has been rising 10 per cent a year and the free cash flow yield is 10.1 per cent. The stock currently trades at 13.9 earnings. A return on invested capital (ROIC) of 46% versus a weighted-average cost of capital (WACC) of eight per cent gives the company plenty of cash flow to raise dividends and innovate further into more gaming/video/audio offerings.

Paychex (PAYX NYSE) – last purchase was Sept. 17 at $108.74 USD

Provides payroll processing and integrated human resource and employee benefits outsourcing solutions for small and medium-sized businesses. Services range from calculating payroll and filing tax payments to administering retirement plans and workers’ compensation. Earnings announced last week were significantly higher than expected. Revised forecasts see earnings growth now in the 12 per cent to 14 per cent range with revenues climbing eight per cent. This is a result of higher scale in Management Solutions revenue and higher margins - it’s now a larger percentage of overall revenues. A return on invested capital (ROIC) of 31 per cent versus a weighted-average cost of capital (WACC) of 12 per cent gives the company plenty of cash flow to raise dividends and innovate further into more digital payroll and HR offerings.

Cloroplast A/S (COLO-B CPH) – last purchase was Sept. 17 at 1,092.50 DKK

Makes products for ostomy, incontinence, mastectomy, wound healing and skin care. The stock is off 16 per cent from its 1187 DKK high as the COVID-19 lockdown has aborted elective surgeries in hospitals. Like Logitech, a higher price move will depend on a re-opening of the economy. A return on invested capital (ROIC) of 38 per cent versus a weighted-average cost of capital (WACC) of six per cent gives the company plenty of cash flow to raise dividends and innovate further into more ostomy and other abdomen health products.

PAST PICKS: Feb. 10, 2021

Nutrien (NTR TSX)

• Then: $70.13
• Now: $87.16
• Return: 24%
• Total Return: 27%

Thermo Fisher Scientific (TMO NYSE)

• Then: $484.88
• Now: $587.33
• Return: 21%
• Total Return: 21%

Novo-Nordisk NV (NOVO-B CPH)

• Then: Kr 433.80
• Now: Kr 638.10
• Return: 47%
• Total Return: 49%

Total Return Average: 32%