Jason Mann, chief investment officer at EdgeHill Partners
Focus: North American equities

MARKET OUTLOOK

Global equity markets remain in an uptrend, but we’d argue it’s a more tentative one with leadership narrowing somewhat and small caps continuing to lag. Global markets overall haven’t made any headway overall in 18 months.

Markets appear “stuck in the middle” between two divergent views. On one hand, bonds are arguing for more than one rate cut as global growth continues to slow and inflation declines. The yield curve isn’t suggesting an immediate recession, but is positioning for one sooner rather than later. On the other, stocks are arguing for a resolution in the trade wars, a rate cut that stokes renewed growth and little recession concern.

If bonds are correct, you likely get further strength in bond proxies and defensive sectors like REITs, utilities and gold as rates fall further and the yield curve flattens. If stocks are right, then the market likely rotates to more cyclical sectors, with industrials, materials and even energy picking up the baton. These have the benefit of much more reasonable valuations than defensive and growth sectors, but they absolutely rely on the market believing that rates are going higher and that broad global growth will return.

We’re positioned somewhere in the middle of these two outcomes. We find the most defensive stocks like utilities to be expensive, as are high-priced growth stocks. At the same time, the very cheapest cyclical sectors like energy and materials have too much negative price momentum for us to own. We end up pushed to the middle, where we find decent valuation and decent price trends in industrials, financials and consumer discretionary sectors.

TOP PICKS

WESTSHORE TERMINALS (WTE.TO)

This company owns a leading coal export terminal on the West Coast, providing coal to both the thermal and metallurgical markets. Volumes have been recovering, with Westshore recently increasing guidance on that front even though U.S. thermal coal has been weak.

 Valuation isn’t as cheap as it was back in 2015 at what were arguably cyclical lows, but it’s still quite good and the company is in the top 5 per cent out of all stocks on valuation. The company trades at 8.5 times enterprise value to EBITDA, 11.2 times price to earnings (P/E), 20 times return on equity (ROE), has a solid balance sheet and yield of three per cent. That yield is well supported by a low 35-per-cent payout ratio. We would expect to see return of capital though special dividends or share buybacks as they generate excess cash. If we get a cyclical growth recovery, they’re well positioned and you won’t go broke owning them while you wait. The dividend is sustainable, and they own a strategic asset that can’t be replicated.

NORTHLAND POWER (NPI.TO)

Northland is a developer and operator of clean power facilities, with assets in Canada, the U.S. and Germany. It operates solar, wind (onshore and offshore) and thermal assets. All of their projects are contracted, but they do have renewal pricing risk, development risks and wind variation risks, so quarters can be somewhat lumpy.

They initiated a strategic review back in 2016, but ultimately after a year they ended the review without a sale. Today, they have a good development pipeline for growth, with projects in Mexico, Germany and Taiwan, which is likely not fully reflected in valuations.

This is a slow and steady business, so it’s likely to be stable in an environment where markets (and rates) do roll over. It’s reasonably priced at 10.4 times EBITDA, has good ROEs and is generally viewed as a good operator. Its 4.7-per-cent yield is supported by a reasonable 80-per-cent payout ratio. Price momentum is good as well, trading near highs but not up as much as many utility peers and not as expensive.

IA FINANCIAL (IAG.TO)

IA is a Quebec-based company offering insurance, financial advice, brokerage and other services. This is a “down the middle” pick in the sense that they have a diversified financial business that can hold up relatively well in a downturn. It also has a growth mandate that will drive performance if the overall market improves and an insurance business that does better with higher rates. It’s not likely to be a homerun, nor is it likely to be a disaster.

IA generates $200 million in excess capital per year and is looking to deploy over $1 billion in capital for growth, likely in the U.S. The valuation is reasonable at 9.4 times P/E, it has a good balance sheet, and its yield is at 3.4 per cent with room to grow given a low payout ratio of 28 per cent. Price momentum has been improving, and it scores well on the stability of its business and share price.

PAST PICKS: JULY 6, 2018

HUSKY ENERGY (HSE.TO)

• Then: $20.32
• Now: $10.67
• Return: -47%
• Total return: -46%

ELEMENT FLEET (EFN.TO)

• Then: $6.20
• Now: $10.61
• Return: 71%
• Total return: 76%

ARITZIA (ATZ.TO)

• Then: $15.99
• Now: $17.49
• Return: 9%
• Total return: 9%

Total return average: 13%

WEBSITE: www.ehpfunds.com