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

MARKET OUTLOOK

While acknowledging the strength of the stock market this year on optimism about further central bank easing, we still believe that investors are too hopeful about the economic outlook. Growth has been slowing globally since the middle of 2018 and this slowdown is being exacerbated by rising trade tensions between the U.S and China. We expect profit expectations will be reduced further during the rest of the year and don’t see the risk/reward trade-off as being favourable enough for us to have a substantial overweight position in stocks. But we also understand that there are some factors that may limit the risk in stocks in some sectors. The return to record-low interest rates will support somewhat higher stock valuations, particularly for the defensive sectors of the market such as utilities, telecom and communications services sector. Also, investor sentiment surveys have become notably bearish recently, reaching levels seen at shorter-term market lows. The quantitative models we look at are also once again showing very positive money flows that are often positive contrarian signals for stocks and could provide some more shorter-term strength.

We continue to have overweight positions in mid-term bonds, preferred shares and cash, and are staying with an underweight position in U.S. stocks. Despite the fact that the strength of the U.S. dollar has basically sucked the oxygen out of the room for the entire commodity sector, we have added exposure to some cyclical/resource stocks in Canada, particularly energy and base metals, where we watched a mass exodus of capital create substantially undervalued opportunities, not unlike what we saw in the industrial sector towards the end of the technology boom. We remain cautious on the financial sector due to continued downward pressure on interest rate margins and minimal loan growth. With preferred share yields now over 6 per cent and all of our holdings in extremely safe utility, pipeline and other investment-grade holdings, we still see the risk/reward as very favourable. We also continue to “high-grade” the stock holdings in the portfolio due to overall market risk and the need for liquidity, adding to defensive names such as Rogers, Telus and Enbridge.

TOP PICKS

OPEN TEXT (OTEX:CT) 
Most recent purchase: September 2019 at $52.

Open Text has executed well on its transition from a software licence to cloud-based operating environment, continues to execute on its growth-by-acquisition strategy and trades at a significant discount to other Canadian tech companies with similar strategies. Record-free cash flow is supporting ability to pursue a range of acquisitions, with management positive on its opportunity pipeline. They also continue to deepen relationships with key customers in order to deliver improved organic growth and are seeing greater adoption of its products into their installed base of 74,000 customers.

VANECK VECTORS GOLD ETF (GDX:UN)
Most recent purchase: May 2019 at US$23.70.

Zero/negative global interest rates have dramatically reduced the opportunity cost of holding “non-yield” gold. Competitive global currency depreciation also should shift funds towards gold as the “anti-paper currency.” Gold stocks are trading at decades-low valuations relative to bullion and are a better way to lever its upward move. We prefer the large-cap oriented GDX ETF, with its diversity of major gold stocks such as Barrick, Newmont, Franco Nevada, Agnico and Newcrest in order to reduce specific mine risk as well as geographical diversification.

BAYTEX ENERGY (BTE:CT)
Most recent purchase: September 2019 at $1.80.

Don’t need to be an energy bull to be positive on Baytex at current levels. The company has reduced financial leverage dramatically in the past three years as it generates free cash flow at current strip prices. There is a misconception that majority of production is priced at WCS, but it now sells a large amount of oil from the U.S. Permian Basin and therefore receives market prices. At current WTI oil prices, the company will generate substantial free cash flow this year and we expect the leverage ratio to drop down to 1.5 times from over four times in 2018, giving it the financial flexibility to continue drilling, pay off additional debt, pursue another acquisition, or reinstate a dividend. The stock is trading at a discount to net asset value and only about three times operating cash flow.

PAST PICKS: AUG. 27, 2018

NUTRIEN (NTR:CT)

• Then: $72.81
• Now: $67.25
• Return: -8%
• Total return: -5%

TREVALI MINING (TV:CT)

• Then: $0.75
• Now: $0.20
• Return: -73%
• Total return: -73%

ALPHABET (GOOG:UW)

• Then: $1,241.82
• Now: $1,204.41
• Return: -3%
• Total return: -3%

Total return average: -27%