Full episode: Market Call Tonight for Monday, November 26, 2018
John Zechner, chairman and founder of J. Zechner Associates, Inc.
Focus: North American large caps and investment strategy
We continue to believe that global economic and profit growth peaked for this cycle in the second quarter. Leading economic indicators from the industrialized (OECD) countries have lost momentum as Asian and European manufacturing data turned down and the Economic Surprise Indices have headed lower. Record global debt levels and rising interest rates will lead to retrenchment in consumer and business spending thus limiting further expansion. Profit margins are expected to peak this year due to rising input costs (wages, basic materials). While the U.S. tax cuts have led to double-digit profit gains this year, those cuts are one-time in nature and will diminish in impact by the fourth quarter. We're maintaining a defensive bias as we are late in this economic cycle, interest rates are rising and economic growth is about to slow down. Stock weights therefore remain below average levels. While the sharp fall in stocks in October started to create better buying opportunities, we still think that earnings estimates for 2019 need to come down. We also expect rising interest rates to provide competition to stock returns as well as increasing the risk of a “negative liquidity event” due to the proliferation of new investment products created in the low interest rate environment.
On the positive side, the stock market is clearly oversold in the very short term and would respond positively to any news on a potential lessening of trade issues between the U.S. and China at the upcoming G20 meeting or if the U.S. Fed indicates some more dovish outlook on interest rates that is more “data-dependent.” We also see little further downside risk in the energy sector in Canada as the mass exodus of capital since 2015 has created attractive valuations despite the recent weakness in crude oil. We also expect some recovery in commodity prices as China moves to stimulate growth again and the U.S. dollar comes under pressure due to massive deficit fund requirements over the next few years. We continue to have an overweight position in cash, short-term bonds and preferred shares and an underweight position in both Canadian and U.S. stocks. Sectors we continue to favour in the stock market due to their inherently low valuations and growth potential include the energy stocks and the auto parts sectors in Canada and communications and technology stocks in the U.S. market.
TREVALI MINING (TV.TO)
Latest purchase at $0.45 in November.
Trevali is a multi-mine base metals producer focused on the production of zinc, with 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 should 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, and then do further accretive acquisitions or buy back a substantial amount of the existing stock. With zinc fundamentals remaining firm, improving operating results and cash generation, we expect Trevali can be re-rated to a much higher level.
BAYTEX ENERGY (BTE.TO)
Latest purchase at $2.35 in November.
Following the acquisition of Raging River, the improvement in the balance sheet and oil prices remaining high, Baytex Energy should be re-rated to a higher valuation. The stock has been unduly hurt due to belief that it is still a major producer of heavy oil and therefore receiving substantially low prices than WTI, but the reality now is that it sells a large amount of oil from U.S. Permian Basin and therefore receives market prices. Assuming WTI oil averaging around US$60 over the next year, the company could generate between C$500 million and C$700 million in free cash flow. That would push Baytex Energy's leverage ratio down to a more comfortable 1.5 times, giving it the financial flexibility to continue drilling, pay off additional debt, pursue another acquisition, or reinstate a dividend.
MAXAR TECHNOLOGIES (MAXR.TO)
Latest purchase at $20 in October.
The satellite and space systems manufacturer and operator has fallen over 40 per cent in 2018 despite the successful acquisition of Digital Globe in 2017, which helped to integrate its total satellite orbit offerings by putting together the satellite manufacturing business of MacDonald Dettwiler with the mapping and data capabilities of DGI. But a negative research report by Spruce Point Capital Management, a hedge fund with a track record of launching negative campaigns against North American public companies after taking a short position in their stock, caused investors to “sell first and ask questions later.” Investors remain in a “show me” mode and it will take some quarters of earnings growth to convince the skeptics (and short sellers) that the stock has more upside than downside. Improvement of free cash flow with a priority to pay down debt is of primary importance. Strong free cash flow generation will allow them to pay down acquisition debt relatively quickly. Valuation exceptionally low at under 8 times forward earnings and 7 times forward EV/EBITDA. The biggest risk is a gradual shift away from the geo-satellite market in favour of other monitoring instruments such as drones.
PAST PICKS: NOV. 6, 2017
TRINIDAD DRILLING (TDG.TO)
- Then: $1.81
- Now: $1.63
- Return: -10%
- Total return: -10%
- Then: $1025.90
- Now: $1048.62
- Return: 2%
- Total return: 2%
HUDSON’S BAY (HBC.TO)
- Then: $11.95
- Now: $8.23
- Return: -31%
- Total return: -31%
Total return average: -13%
JZAI Global Hedged Growth Fund
Performance as of: Oct. 31, 2018
- 1 month: 1.68% fund, -6.27% index
- 1 year: -0.98% fund, -3.41% index
- 5 years: 2.14% fund, 5.14% index
Index: Fundata Inc.
Returns are net of fees.
TOP HOLDINGS AND WEIGHTINGS
- Short: Vaneck Vectors Semiconductor ETF: 5.95%
- Short: SPDR Trust Unit S&P500 (SPY): 8.16%
- Short: iShares Russell 2000 ETF: 7.87%
- Short: NASDAQ 100 Powershares (QQQ): 6.93%
- Long: iPath VIX Short-Term Futures ETF: 5.96%
- Short: Vaneck Vectors Semiconductor ETF: 5.95%