John O'Connell, chairman and CEO of Davis Rea

Focus: North American large caps


MARKET OUTLOOK

There has been lots of volatility in the market recently. Asset prices and housing are adjusting to the new interest rate environment: after several years of zero short-term and 1 to 2 per cent 10-year government yields, asset prices are adjusting to 2 per cent short-term and 3 per cent 10-year rates. Global trade tensions continue to be a worry and a downside risk to economies and earnings; after ignoring it in 2017, markets are now factoring it in. The economic evidence, however, suggests that trade is slowing but not collapsing. Global economic indicators show a cyclical moderation in growth, with no sign of the material slowing that markets and many commentators are assuming.

U.S. economic may be peaking and is very likely to downshift in response to higher rates and fiscal stimulus fading. Despite this, the recession risk for the global, U.S. and Canadian economies in 2019 still looks low. Earnings growth is likely close to a peak helped by corporate tax cuts, but the level of earnings will continue to rise through 2019. Multiples have contracted in this market correction, but could contract further on interest rate and trade fears along with the prospect for lower earnings growth rates. Yet a considerable amount of bad news seems to be baked in at the moment. Moreover, interest rate risks have eased in light of recent comments from the U.S. Federal Reserve and the Bank of Canada and the fact that the U.S. and China are talking implies a potential peaking in trade tensions.

TOP PICKS

John O'Connell's Top Picks

John O'Connell of Davis Rea shares his top picks: Goldman Sachs, Wells Fargo and JPMorgan Chase.

GOLDMAN SACHS (GS.N)

Goldman Sachs is one of the largest investment banks in the world. It has been using excess capital to return capital to shareholders both through dividend increases and share repurchases. The return of volatility has been helpful for Goldman, as its fixed income, currencies and commodities (FICC) and its equities businesses reported stronger results last quarter.

The bank has expanded its retail presence with an online banking product for savings accounts and personal loans. It also has made inroads on building out its commercial banking business. Goldman will benefit from increased capital markets and M&A activity, but it has also grown its investment management business to 20 per cent of its revenue, which is more stable. From a valuation basis, Goldman is also trading at more attractive price-to-book and price-to-earnings multiples versus its investment banking peers.

The bank has recently been embroiled in the 1MDB scandal, but we view this as a manageable loss as the amount of a potential fee is manageable and the problem appears to be limited to the company’s Southeast Asia office. Goldman is continuing to improve its financial metrics, reporting record return on equity levels and starting to see some of their growth initiatives play out.

JPMORGAN CHASE (JPM.N)

JPMorgan Chase provides global financial services and retail banking to institutions and individuals. It’s the largest bank holding company in the U.S. and top 5 in the world, with more than 5,000 branches in America. It’s also one of the U.S.’s top mortgage lenders and credit card issuers and has strong investment banking and asset management operations, with more than US$2.5 trillion under management. We believe the company is well positioned to benefit from rising interest rates in the U.S., increased consumer spending (and borrowing) and the recent legislation that was passed reducing tax rates going forward. We believe that JPMorgan will return more capital to shareholders over time, both through dividend increases (the shares currently yield 2.45 per cent) and share re-purchases. JPMorgan continues to lead the rest of its financial peers in technology investments to help drive revenue growth and reduce expenses.

STANLEY BLACK & DECKER (SWK.N)

DISCLOSURE PERSONAL FAMILY PORTFOLIO/FUND
GS Y Y Y
WFC Y Y Y
SWK Y Y Y

PAST PICKS: JULY 25, 2017

John O'Connell's Past Picks

John O'Connell of Davis Rea reviews his past picks: Accenture, Goldman Sachs and Wells Fargo.

ACCENTURE PLC (ACN.N)

  • Then: $128.95
  • Now: $160.23
  • Return: 24%
  • Total return: 28%

GOLDMAN SACHS (GS.N)

  • Then: $221.58
  • Now: $175.95
  • Return: -21%
  • Total return: -19%

WELLS FARGO (WFC.N)

  • Then: $55.06
  • Now: $47.04
  • Return: -15%
  • Total return: -11 %

Total return average: -1%

DISCLOSURE PERSONAL FAMILY PORTFOLIO/FUND
ACN Y Y Y
GS Y Y Y
WFC Y Y Y

FUND PROFILE

Davis Rea Equity Fund

Performance as of: Nov. 30, 2018

  • 1 month: -3.27% fund, 1.46% index
  • 1 year: -6.47% fund, -0.6% index
  • 3 years: 0.99% fund, 7.0% index

Index: 50% S&P/TSX60 Index, 50% S&P 500 Index.

Returns are gross of fees.

TOP 5 HOLDINGS AND WEIGHTINGS

  1. Brookfield Infrastructure Partners: 6.4%
  2. Gear Energy Ltd: 6.3%
  3. Cenovus Energy: 5.1%
  4. Kelt Exploration Ltd: 5.0%
  5. The Walt Disney Company: 5.0%

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