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

MARKET OUTLOOK

The story in 2019 was impressive stock market returns despite growth near recessionary levels, but over 90 per cent of the gains were due to higher earnings valuations as opposed to earnings growth. While chronic low rates can explain much of the multiple revaluation, there is a limit to how far multiples and stocks can rise without underlying earnings growth. While recent ISM surveys did show some rebound and contributed to a late 2019 rally and optimism for 2020, growth remained below trend in almost all geographic regions. Most importantly, all of these weak economic readings are before the onset of the coronavirus. Those numbers will only worsen going forward.

We expect profit estimates will have to be reduced further and generally see the risk/reward trade-off as being unfavourable for stocks. The renewed ease from central bankers and the return to record-low interest rates have supported higher stock valuations, particularly for the defensive sectors of the market. We have maintained positions in key growth sectors of the U.S., with large technology stocks and core “reasonable-priced” growth names. In Canada, we like the telecom stocks for safety and yield and the energy sector for multi-decade low stock valuations and more shareholder-friendly corporate management behaviour. We continue to carry a 4 to 5 per cent weight in gold stocks due to historically low valuations and as a portfolio hedge. We also continue to have overweight positions in mid-term bonds as we expect a decline in interest rates as well as preferred shares due to their strong, absolute yields. We have reduced cash balances to levels needed for portfolio liquidity only as the return on cash remains uncompetitive to other assets.

TOP PICKS

BLACKBERRY (BB TSX)
Last purchase at $6.75 on October 2019.

Under John Chen, BlackBerry has achieved a phenomenal turnaround from a fading maker of smartphones to a pure software firm with competitive strength in cybersecurity and auto Internet of Things software. In the process, the company has maintained positive cash flow with a strong balance sheet and is now showing double-digit revenue growth in its core competencies. However, it’s trading near multi-year lows despite a favourable valuation, with a slide of almost 40 per cent over 2019 while most other tech stocks have rallied. While the company has been hurt by near-term execution issues, investors are overlooking some key assets, such as Cylance, QNX, and Athoc, as well as the long-term growth in cybersecurity.

ROGERS COMMUNICATIONS (RCI/B TSX)
Latest purchase at $64 on September 2019.

In the current slower growth environment, we think the telecom sector provides the best risk/reward combinations for investors with low volatility, cash flow growth and a strong dividend growth model. These companies continue to benefit as being the “highways” for the continuing massive growth in high bandwidth data flow and their ability to bundle those services for consumers. Less appreciated are the benefits of owning all the long-life spectrum and other communications and infrastructure assets at a significant discount to other long-term capital assets. Rogers trades at under 8 times EV/EBITDA and generates significant free cash flow. Unlimited data plans and other pricing pressures will reduce the average revenue per user, but the growth of 5G and streaming will also increase usage dramatically and lead to continued cash flow growth.

MAXAR (MAXR TSX)
Latest purchase at $12 on October 2019.

Maxar is an integrated space and geospatial intelligence company with a full range of space technology solutions for its customers, including global satellite operators and government and corporate clients. The 2017 acquisition of Digital Globe has allowed Maxar to merge its satellite and space hardware manufacturing with the company’s software and analytic capabilities, a potent and attractive offering for companies and governments looking for imaging data for marketing, defence or analysis. The addition of debt to make the acquisition and the need to finish building out the low-level satellite orbit has disappointed investors who were looking for a quicker paydown of the debt. While that presented risks, the valuation of the stock has more than accounted for those risks such that further success in paying down debt and resuming growth should lead to sharp gains in the stock price.

PAST PICKS: JULY 15, 2019

VANECK VECTORS GOLD ETF (GDX NYSE)

• Then: $26.18
• Now: $28.45
• Return: 9%
• Total return: 9%

WALT DISNEY (DIS NYSE)

• Then: $145.06
• Now: $142.12
• Return: -2%
• Total return: -1%

BAYTEX ENERGY (BTE TSX)

• Then: $1.88
• Now: $1.35
• Return: -28%
• Total return -28%

Average total return: -7%