John Zechner, chairman and founder at J. Zechner Associates
Focus: North American large cap stocks

MARKET OUTLOOK

We head into 2021 with the most widely held consensus on both economic activity and stock market performance we have seen in decades. That alone tends to make us a bit nervous, especially with stock market valuations at record levels, investor sentiment ragingly bullish and speculative activity continuing to surge (think Tesla, SPACs, Bitcoin and IPO fever). Investors expect economic growth to rebound, which makes sense given that millions of COVID-19 vaccine doses are on track for distribution, new fiscal stimulus packages are on the way and central banks remain adamantly supportive. In our view, economic growth will meet these expectations, with continued manufacturing recovery boosted by a pent-up demand for service spending in areas such as travel and entertainment. The “fly in the ointment” could be a reversal of the interest rate declines that have been so supportive of valuations in the growth sectors of the stock market.

Few investors expect any inflationary pressure, but we have never before seen the amount of monetary expansion we saw in the past year in any industrialized economy. If growth does indeed recover as expected, we would almost certainly see some upward pressure on prices of goods. While central banks are adamant that they will keep interest rates at these record low levels right through 2023, we wonder how they could maintain that stance if we suddenly see economic growth back in the 3 per cent range and inflation running at a similar rate. The risk is that 2021 ends of looking a lot like 2018 where profits and growth soared but so did interest rates, which proved too much for a stock market that had been levitated by low rates.

Despite this risk, we remain overweight in stocks as they still represent the most attractive alternative to bonds or cash. We are avoiding the high growth, high valuation sectors and focusing instead on recovery sectors that can still work in a higher interest rate environment. Financials in both the U.S. and Canada lead that list, but we have also added to energy, industrials, base metals, autos and even some airlines. The biggest focus in our portfolios is on the stable dividend payers such as pipelines, telecom stocks and banks, where yields exceed 5 per cent and val2uations are relatively depressed. We have also added to preferred share portfolio as rate reset risks have diminished.

TOP PICKS

Shaw Communications (SJR/B TSX) Most recent purchase: $22 on September 2020

In our view, the telecom sector provides the best risk/reward combination for investors with low volatility, positive free cash flow, reasonable valuations and high-dividend yields with growth. Less appreciated are the benefits of owning all the long-life spectrum and communications infrastructure assets at a significant discount to other long-term capital assets. Shaw trades below six times EV/EBITDA, generates significant free cash flow and has paid down acquisition debts . Results in 2020 beat expectations as the growth of Shaw/Freedom wireless was better than the incumbents and they have a relatively stronger balance sheet with lower expected spectrum cost. COVID-19 impacts (store closures, subdued subscriber activity and reduced roaming fees) have been managed well and broadband trends are improving with the growth of 5G and streaming expected to increase further.

CIBC (CM TSX) Most recent purchase: $110 on December 2020

Financial stocks lagged the overall market in 2020 as fears about substantial loan losses, economic risks and record low interest rates hampered expectations. But the banks delivered solid results with strong capital ratios, continued growth in wealth management and surprising strength in capital markets and trading. CIBC has excess capital and has probably overprovisioned for potential loan losses, so we expect those reserves may come back into earnings and dividends could be increased again along with the reinstitution of share buybacks. CIBC’s expansion into the U.S. is now contributing to net earnings yet the valuation gap to the rest of the bank group remains wide, and we expect that differential to narrow. Meanwhile the bank dividend yield is in excess of 5 per cent.

Tourmaline Oil (TOU TSX) Most recent purchase: $17 on December 2020

We see a bullish backdrop for natural gas pricing fundamentals over 2021 and Tourmaline is the best way to play the gas-weighted producers. The company has one of the best balance sheets in the industry, a low-cost asset base and one of the strongest management teams, who have also have been aggressive buyers of their own stock. Strategic corporate acquisitions and dispositions have added value, including recent purchase of Modern Resources and Jupiter Resources, which provide an additional 76,000 barrels per day of current production. The transactions are immediately accretive on virtually all relevant metrics as the company ramps up production on the acquired lands and fully captures what could be some significant cash flow and free cash flow. The spinout of Topaz Resources has also crystallized value for that asset and becomes a source of funding for future acquisitions.

PAST PICKS: DEC. 10, 2019

Fedex Corp (FDX NYSE)

• Then: $157
• Now: $261.14
• Return: +66%
• Total Return: +68%

Crescent Point Energy (CPG TSX)

• Then: $4.98
• Now: $2.95
• Return: -41%
• Total Return: -40%

Blackberry Ltd. (BB TSX)

• Then: $7.13
• Now: $8.69
• Return: +22%
• Total Return: +22%

Total Return Average: +17%