Gordon Reid, president and CEO, Goodreid Investment Counsel

FOCUS: U.S. equities

MARKET OUTLOOK:

The question of the day is: Will the Fed’s actions to control inflation drive the economy into a recession? The answer, of course, is dependent on other factors such as whether the rate of inflation abates naturally or whether it remains stubbornly high. Much of the inflationary pressure we are feeling comes out of the broad influences felt as the result of the pandemic.

Supply constraints led to the normal supply/demand relationship being upended. On top of that, demand was suppressed during the height of the shutdown and was exaggerated coming out of it. Finally, the world’s workforce has experienced tectonic shifts. Are there permanent labour shortages that will lead to ongoing wage inflation? Will wage increases move in line with general goods inflation? The answers to these questions provide clues to future economic cycles.

The Fed is being very aggressive in its rhetoric and it’s having the intended results. The bond market has spoken and anybody who is waiting for the point in time that the Fed raises rates is missing the point. Interest rates have already driven higher, off a 2020 low for the U.S. 10-year Treasury of 0.5 per cent to today’s yield of three per cent. The equity markets are scrambling to re-rate to conform to the bond market move.

We hear a lot about “peak” this and “peak” that. We think the most important “peak” to watch for is fear. We are at an extreme point of negativity and pessimism. Goodreid’s experience is that the market invariably over-shoots, so we may have room on the downside, but we think it will be short-lived. Watch for a catalyst to change sentiment. A more permanent reversal will be brought on by indications that inflationary pressures are abating, and the Fed pausing in its hawkish rhetoric and moves. Also, watch seasonality. It is a mid-term election year in the U.S. Historical market action is very interesting.

Corporate releases of financial reports for Q1 are close to 50 per cent in. One interesting aspect is the strength of revenues, so far showing a year-over-year advance of greater than 10 per cent. This indicates that demand is very strong but also shows that companies are passing through costs. Further analysis shows profits up close to seven per cent, short of revenue growth leading to declining margins. In other words, demand is strong and corporations are passing through costs to a large extent, but not fully.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

​

TOP PICKS:

CVS Health (CVS NYSE)

• Latest purchase April 2022 at $97

CVS Health had an outstanding year in 2021, and while its long-term trajectory is excellent, earnings in 2022 are likely to be little changed, the result of COVID-related revenues offset by organic advances in business. CVS is a powerhouse in U.S. healthcare, sporting a major insurance division, a pharmacy benefit manager, and a fulfillment division of 10,000 physical locations, filling one-billion prescriptions per year. At 12X earnings, this defensive holding is a buy.

Jacobs Engineering (J NYSE)

• Latest purchase April 2022 at $150

Jacobs provides exposure to the construction and engineering space as well as the burgeoning rollout of 5G technology. At 19X estimated 2022 earnings and sporting solid double-digit growth potential of both earnings and cashflow, this issue is compelling, and the attractiveness will only increase with an infrastructure bill in the U.S.

Merck (MRK NYSE)

• Latest purchase April 2022 at $89

Merck is a timely stock in a distressed market. A triple “A” balance sheet, strong earnings predictability and a relatively recession proof business makes it a good choice, but that is not reason enough to own a stock. What puts Merck in our portfolio is its strong pipeline, growing earnings and cashflow at two to three times GDP, a dividend yield of 3.5 per cent and an attractive valuation of 12 times earnings.

Facebook (FB NASD)

• Then: $327.79
• Now: $208.48
• Return: -36%
• Total Return: -36%

General Motors (GM NYSE)

• Then: $56.76
• Now: $38.94
• Return: -31%
• Total Return: -31%

Lear Corp (LEA NYSE)

• Then: $185.94
• Now: $129.27
• Return: -30%
• Total Return: -29%

Total Return Average: -32%