John Zechner, chairman and founder of J. Zechner Associates
Focus: North American large caps

MARKET OUTLOOK

Stock market strength has been driven by record-low interest rates, strong global growth and rising profits enhanced by U.S. tax cuts. But these are all well known facts. A stock market outlook is based on future developments, where we see storm clouds gathering. 

Synchronous global recovery is losing steam as a higher U.S. dollar, international trade frictions, record global financial leverage and rising interest rates all put current expansion at risk of slowdown. We’re already seeing breakdown in many emerging markets reminiscent of the late ‘90s and slower growth in Asia. Copper prices falling and U.S. bond yields stalling are indicative of slowing growth and put in question the bullish stock market outlook. 

Bulls claim this has been a “hated bull market” that still has lots of upside, but data shows U.S. stocks as a percentage of total financial assets are near record highs (exceeded only once in the last days of the technology bull market). The zero interest rate policy that fueled the shift to financial assets is being removed, which will increase attractiveness of stock alternatives and dry up the giant liquidity bubble that’s driven stocks to record valuations.

The U.S. remains sole geography of global growth, but this was due to an “adrenaline shot” given to the economy through massive tax cuts and deficit spending. The impact of those tax cuts on earnings will start to fade by the fourth quarter, just as companies are warning that rising input costs and trade tensions are putting profit growth at risk. Economic stimulus this late in the cycle will only raise inflationary risk, meaning that the U.S. Fed will need to continue tightening monetary conditions. Debt has also risen to record US$22 trillion and will rise further, with deficits expected to exceed US$1 trillion annually over the next few years. Massive U.S. borrowing needs will eventually lead to weakening American dollar and should give lift to commodity prices, maybe even gold. 

Commodity stock valuations represent one of few valuation opportunities in the stock market. ETF money flows have funded the global bull market and we’ve seen those flows shift from bonds and global stocks to U.S. technology stocks in the past year. 

When this bubble ends and the buying turns to selling, valuations will overreact on the downside to the same degree that they’ve exceeded normal values on the upside in recent years. We’re staying conservative, with slight overweight positions in cash, short-term bonds and commodity stocks. We also have reduced positions in U.S. technology stocks (which remain the best long-term growth stories) and maintain market weight positions in U.S. financial stocks.

TOP PICKS

NUTRIEN (NTR.TO)
Bought at $61 in March 2018.

Global fertilizer prices are recovering from recent lows and entering new phase of expansion as crop plantings increase and supply growth remains muted. Nutrien has become the go-to player in the industry, with leading positions in both potash and nitrogen-based fertilizers. Asset dispositions and increasing vertical integration have led to improved profit margins and a stronger balance sheet, which will also allow for a greater proportion of stock buybacks. We’re early in the recovery and the fundamentals of the industry are improving. “By the 2020-21 year, the supply-demand fundamentals could even be tight,” Nutrien says.

TREVALI MINING (TV.TO)
Bought at 70 cents in August 2018. 

Trevali is a multi-mine base metals producer focused on the production of zinc, with four operating mines in Canada, Namibia, Burkina Faso and Peru. Zinc prices are at their highest levels since 2007, driven by a significant supply squeeze and strong demand. Trevali is one of the only pure-play multi-asset zinc producers listed in North America. It’s poised to generate "substantial" free cash flow at current zinc prices over the next two years and could be sitting on a net cash position (which is close to the market value of the entire company today) at which point they could engage in further accretive acquisitions or buy back a substantial amount of the existing stock.

ALPHABET CLASS C (GOOG.O)
Bought at US$920 in August 2017. 

Alphabet remains the top choice in large-cap technology, as they dominate in key growth areas of search and online advertising. The company continues to produce impressive financial performance, with growth exceeding 20 per cent for 32 consecutive quarters and accelerating versus prior quarters. It’s seeing improved and strengthening prospects from mobile and YouTube advertising as well as increased traction in the company’s cloud business. On top of this, they own the (not yet monetized) Android operating system, which supports over 60 per cent of global wireless devices. Alphabet also has other growth initiatives underway, ranging from Nest and the Pixel smartphone, to the company’s autonomous vehicle unit Waymo. The fundamentals behind the numbers remain as strong as ever from a qualitative perspective. Large cash generation also gives the company liquidity to expand further. Valuation is exceptionally low given its growth profile and offers attractive upside at current price.

PAST PICKS: FEB. 15 2018

OPEN TEXT (OTEX.TO)

• Then: $44.12
• Now: $50.46
• Return: 14%
• Total return: 15%

QUALCOMM (QCOM.O)

• Then: $65.28
• Now: $67.34
• Return: 3%
• Total return: 5%

VANECK VECTORS OIL SECTOR ETF (OIH.O)

• Then: $24.20
• Now: $25.27
• Return: 4%
• Total return: 4%

Total return average: 8%

FUND PROFILE

JZAI Global Hedged Growth Fund
Performance as of: June 29, 2018

• 3 Months: +2.30% fund, +1.77% index*
• 3 Years: +3.30% fund, +3.14% index
• 5 Years: +6.57% fund. +4.62% index

* Index: Fundata Alternative Strategies Index.
* Fund's returns are after fees and are third-party measured by Fundata.

 TOP 5 HOLDINGS AND WEIGHTINGS 

1. Long: Canadian Energy Sector: 11.7%
2. Short: iShares S&P500 ETF: -8.0%
3. Short: iShares Russell 2000 ETF: -8.0%
4. Short: Nasdaq100 Power Shares: -6.8%
5. Short: Air Canada: -4.8%

WEBSITE: www.jzechner.com