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

MARKET OUTLOOK

Global equity markets are in a tentative uptrend that appears to be improving, but we’d argue that its generally been confined to defensive stocks or stocks with high growth, and more value-oriented sectors have been left for dead.

Markets have spent the last six months “stuck in the middle” between two divergent views. On one hand, bonds are arguing for continued rate cuts as global growth continues to slow and inflation declines; the yield curve isn’t suggesting an imminent recession, but is positioning for one sooner rather than later. On the other, stocks are arguing for a continued resolution in the trade wars, a bottoming in global growth and a turn higher, and no recession.

The tide may be turning though in terms of the “growth versus value” debate. We think there are emerging signs of economic bottoming that favours value again much like in 2016.

In September there was an interesting event: a “momentum massacre.” Stocks that had been in an uptrend (largely growth, low volatility, and defensive) suddenly declined en masse and stocks that had been in a downtrend (mostly lower-quality cyclicals) rallied sharply. It was the fastest, largest rotation in a decade, but more importantly these types of “regime shifts” have marked turning points in major trends. Typically, it means that the old trend is dying and a new trend is emerging.

In our view, the highest-risk stocks to own now are the most expensive growth stocks, particularly U.S. tech stocks. If we have an economic growth recovery, these stocks are likely to lag more value-oriented sectors. If we do roll into a recession, these growth stocks will get hammered. We’ve already seen it in the cannabis sector this year, as the bloom has come off the most speculative growth stocks.

We’re positioned somewhere in the middle of these two outcomes: we find the most defensive stocks like utilities are expensive, as are high-priced growth stocks once again. 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, long financials, industrials and consumer discretionary sectors.

TOP PICKS

GRANITE REIT (GRT-U:CT)

In general, we’ve been finding that the REITs are too expensive as a group as a result of the defensive rally this year, but that’s not true in every case.

Granite is the spin-out of Magna’s real estate holdings and Magna continues to be its largest customer. They have portfolio of industrial, logistics, warehouse properties in North American and Europe. Logistics and warehouse properties are now half their portfolio, a growing part of the market given the shift away from retail malls to online retailers.

It’s a very stable business and the stock scores highly for us on volatility. It has good yield at 4.4 per cent with a low payout ratio, so there’s room to grow the dividend. It trades slightly above their industrial peers, but their solid balance sheet perhaps deserves a bit of a premium. Price momentum is strong as well.

TOROMONT INDUSTRIES (TIH:CT)

Toromont is a distributor for Caterpillar heavy equipment, construction and power systems. A few years back it consolidated by buying Hewitt, adding Quebec distribution. It’s done a good job integrating and driving efficiencies.

Toromont has held in well in what has been a tough environment. The stock is clearly tied to a cyclical recovery, although the gold industry can be a bit counter-cyclical to base metals and other industries.

The combination of decent valuation, decent stability and improving price momentum is what’s driving this recommendation. It’s not amazingly cheap, but has good return on equity at 18 per cent and a solid balance sheet with almost no debt. It has a small 1.6-per-cent yield, but only a 28-per-cent payout ratio, so it has room to use their cash flow for dividends or further acquisitions.

BRP INC (DOO:CT)

BRP has pulled back into tail end of 2018, with a combination of selling from their private equity owners, weaker earnings and fears of U.S.-Mexico tariffs, but it has been improving again posting stronger results. It did a substantial issuer bid in the spring and bought back $300 million of their stock near the lows. They have room to do more of that, or use cash flow for M&A.

BRP fits the theme of a cyclical recovery. Their products are a direct beneficiary of strong consumer sentiment and continued job growth. Ultimately, it’s a growth story at a reasonable price, with improving margins and good management.

PAST PICKS: SEP. 17, 2018

HYDRO ONE RECEIPT (H-IR:CT)

• Then: $28
• Now: $33.33
• Return: 19%
• Total return: 24%

TC ENERGY (TRP:CT)

• Then: $55.25
• Now: $67.56
• Return: 22%
• Total return: 30%

CINEPLEX (CGX:CT)

• Then: $32.06
• Now: $22.43
• Return: -30%
• Total return: -24%

Total return average: 10%

WEBSITE: www.ehpfunds.com