Jason Mann, chief investment officer at EHP Funds

FOCUS: North American Stocks

MARKET OUTLOOK:

Markets continue to rally on the prospect of reopening, low interest rates, and massive fiscal stimulus from the Biden administration.

The leadership has changed though, and we are seeing an acceleration of the “growth to value” trade that we had been expecting for some time. While cyclical value stocks are rallying, which makes sense in a recovery, the more interesting element is that the most speculative parts of the market have sold off sharply.

Speculative sectors like EV, battery makers, space exploration, unprofitable software and SPACs are all well off their highs, and we believe that the “growth at any price” trade may be over for this cycle.

In year two of a bull market, upward progress is choppier than year one, but *quality* value picks up the leadership baton from *deep* value stocks. Quality metrics like return-on-equity, and cash flow become more important than just “we’re not going bankrupt”, and we’ve been rotating toward quality names in financials, industrials and consumer discretionary.

Avoid the overpriced growth stocks – the ARKK ETF and Tesla are two great indicators of the health of that sector. If they fail to make new highs as we suspect, there is still a very long way down from “growth” to “value” for these still very expensive stocks.

The market tends to remain constructive for as long as the Fed does, and so while we think the big risks are a way off, recent “blow ups” of Archegos, Greensill and Woodford are canaries in the coal mine, much as the Bear Stearns mortgage fund failures of 2007. It’s clear that the Fed backstop has emboldened a “re-leveraging” of funds and strategies, and investors should take caution to make sure the funds and investments they hold aren’t over-levered, or holding assets that can’t be sold in a crisis.

TOP PICKS:

Shaw Communications (SJR/B TSX)

This one is a bit of a different type of pick for us, in that is a pure merger arbitrage pick. We use merger arbitrage as a strategy in most of our funds, and we look to profit on the “spread” between the take-out value of a merger and the current price.

In the case of Shaw, they have inked a deal with Rogers, which is a deal that has been discussed for as long as I’ve been in the business, and that has finally become possible as Shaw is finally looking to sell in a friendly deal.

We think this spread is very wide, relative to the probability that this deal is completed. If you buy Shaw today, there is an approximate 24 per cent return including dividends assuming the deal takes about a year to close. The market is implying only ~50 per cent odds of this deal being completed, we think its closer to 85 per cent.

We think that U.S. arbitrageurs, who would normally be buyers of large deals like this, are concerned because they are looking to failed deals south of the border and reading into the same for this one.

We think Rogers and Shaw are highly committed to getting this deal done, even if they have to fully divest Shaw’s entire wireless business. The deal makes sense on the traditional wireline assets alone. The fact that Shaw isn’t participating in the latest wireless spectrum auction is a sign they are willing to “stand down” on wireless as this is the potential point of competition pushback.

The downside of merger arbitrage is that a failed deal can mean a large drop, and that is certainly the case here, but as part of a portfolio of merger arbitrages, we like the risk/reward for this one.

Bank of Nova Scotia (BNS TSX)

It’s actually relatively unusual for us to recommend the Canadian banks, not because we think they are bad businesses, but because there are usually better opportunities in the non-bank financials in terms of valuation.

However, the current environment has us favouring Canadian banks again as the yield curve increases, as employment data strengthens, and as it appears we are in another cycle of commodities/cyclicals working where a good amount of lending profits come from in Canada

In general, banks borrow in the short-term market and lend long (mortgages, loans), and a rising yield curve helps. We also expect reserves taken during the pandemic will be released back into earnings as the worst didn’t materialize. Buybacks and dividend increases are coming as well.

Specific to Scotia, they have been in a period of transition for a number of years and have lagged the other banks, but they are relatively cheaper, should start to see synergies from their wealth acquisitions which have been substantial in recent years.

Normalizing their international business lines are another area for improvement.

Has good value characteristics for us and improving price momentum. 14.5x PE, 4.6 per cent yield, and trades cheaper than most of its peers

Ameriprise Financial (AMP NYSE)

Ameriprise is a wealth manager, offering financial planning, annuities and other retirement products.

Paradoxically, the pandemic has improved the wealth of many people, as evidenced by the massive fund flows into equity products over the last few quarters.

In general, brokerage and asset managers so quite well in a cyclical upturn, and Ameriprise is well position to capitalize.

For use, they score well on both price momentum, as well as valuation, with ROEs in the 30 per cent range which we expect could increase to the 40 per cent range in coming years, and trading at ~12x forward PE.

They expect to look to M&A to both sell their fixed annuity business, which will mean more capacity to continue to add advisory teams or buyback shares.

Pays a small dividend at 1.7 per cent, but a low payout ratio and no net debt gives them a lot of flexibility to either raise the dividend, or return cash to shareholders in other ways if the M&A opportunities aren’t attractive enough.

PAST PICKS: March 10, 2020

PulteGroup (PHM NYSE)

• Then: $39.63
• Now: $53.50
• Return: 35%
• Total Return: 37%

Quest Diagnostics (DGX NYSE)

• Then: $106.34
• Now: $126.28
• Return: 19%
• Total Return: 22%

CT REIT (CRT-U TSX)

• Then: $15.18
• Now: $16.35
• Return: 8%
• Total Return: 14%

Total Return Average: 24%

Website: www.ehpfunds.com