Feb 20, 2018

Mike Newton's Top Picks: Feb. 20, 2018

BNN Bloomberg

Mike Newton , BNN

Mike Newton, director of wealth management and portfolio manager at Scotia Wealth
Focus: North American large caps and ETFs

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MARKET OUTLOOK

In February, we went from “overdue” to “overdone” in less than a week. Over the past few weeks investors have been looking for a story behind the sell-off. The press put quite a bit of emphasis on the deficit and inflation. The consensus narrative holds that rising rates are a headwind for stocks. This view also assumes that yields crossed a line in the sand in late January, triggering February's pullback. Rates at some time will be a problem, but I don’t think just yet. Earnings fundamentals are very strong, both organically as well as from the impact of tax reform. Right now, we have strong bottoms-up corporate fundamentals combined with strong global growth. If there’s a recession on the horizon, it’s presenting few clues.

Most major economies are experiencing a rare moment of optimism in the context of the past decade. For starters, the macro data is positively synchronized and inflation still remains tame. Stock markets’ record highs are no longer relying so much on loose monetary policy for support. Bullishness is underpinned by evidence of a notable uptick in global capital investment. As 2018 progresses, we must bear in mind that we’re moving ever closer to the date when payment for today’s recovery will fall due in the form of higher deficits and higher interest rates. Playing a passive index ETF will prove disappointing at some point. Investors were just reminded that fundamental backdrops can be at risk, but must realize that powerful tailwinds still exist.

At this time, short-term moving averages remain bullishly configured on the U.S. markets despite the downside index action. Given that Canadian equities in general have undergone a more significant technical correction to date than their U.S. counterparts, the situation is a little less clear. Our portfolios are designed to be less constrained, can “go anywhere” and can hold large amounts of cash. Investors will have to try and get outside the conventional thinking of Wall Street and Bay Street. They’ll need to be a little savvier and a little more active going forward. As Mark Mobius recently said: “I was too rigid at times. We would focus too much on metrics like price/earnings and price/book ratios, and didn’t pay enough attention to the total picture. We didn’t have the imagination of what could happen over five or 10 years.”

TOP PICKS

CINEPLEX (CGX.TO)
Most recent purchase: Feb. 7, 2018 at $32.50.

We’re back in a name we exited last summer. Cineplex has pulled back over 15 per cent since the beginning of the year and is close to new lows not seen since November 2012. The dip in the stock price has been driven by challenges in the theatre business. Q4/17 box office results were not as strong as initially predicted, but the good news is that analysts still expect to see earnings growth return helped by box office and concessions and, more importantly, contribution from its growth segments: Digital Media and The Rec Room, which continues to ramp up an anticipated three new locations per year.

Looking towards the next two years, we expect Cineplex to launch Top Golf entertainment boxes, which should further bolster revenue growth. Although growth expectations should be muted going forward due to continuing declining movie attendance, right now Cineplex offers a compelling buying opportunity and is trading at a significant discount at 10.1 times. Shares currently yield 5.3 per cent. Note: Cineplex reports earnings this week.

NETFLIX (NFLX.O)
Most recent purchase: Feb. 13, 2018 at US$258.

The resiliency of Netflix during this recent market correction was admirable. Netflix ended 2017 strong and we expect even greater things going forward as it moves deeper into the potentially huge international market, with them already in 190 countries.

The video-streaming leader added 8.3 million new streaming subscribers in the fourth quarter (including 6.4 million internationally) for a total of 118 million — 25 per cent more than the previous year. I wouldn’t be too concerned with its recent all-time highs and would instead recommend looking out three-to-five years considering that Netflix has only 118 million streaming subscribers in a world of more than four billion mobile broadband subscriptions. A few weeks ago, over 16 brokerages raised their price targets for the company’s shares, as Netflix crossed $100-billion market value for the first time.

HOME DEPOT (HD.N)
Most recent purchase: Feb. 13, 2018 at $181.55.

Home Depot is significantly accelerating investment spending in labor, supply chain, e-commerce and IT, which will improve their long-term positioning well into the future. These multi-year actions should enable Home Depot to widen its competitive moat, further insulate the business against online competition and continue to gain market share for years to come. Accelerating these investments is the right thing to do for the business, given the market’s newer tolerance for such investment spending (think Amazon).

In the near-term, Home Depot’s business should continue to benefit from a U.S. housing market that is recovering. Housing macro data indicate that spending within the home improvement sector continues to improve. This week’s profit beat market estimates for the sixth straight quarter on as more shoppers visited the No. 1 U.S. home improvement chain and spent more on average amid the improving housing market.