Stan Wong, director and portfolio manager at Scotia Wealth Management
Focus: North American large caps and ETFs

MARKET OUTLOOK

Global equities have retreated this month with the MSCI All Country World Index nearly making new all-time highs at the beginning of the month. Year-to-date, the rally has been impressive with the world equity index up around 11 per cent. However, global economic data of late has been softer than expected and U.S.-China trade talks appear to have stalled with tensions ratcheting higher. As well, investors continue to be wary of the risks of an aging economic and market cycle. These factors have led to a consolidation in equities over the past few weeks with the technology, industrials and materials sectors leading the declines.

On the positive side of the conversation, U.S. corporate earnings expectations are recovering, the labour market is solid and monetary policy continues to be accommodative. With the earnings reporting season nearly over, about 77 per cent of S&P 500 companies have announced positive Q1-2019 earnings surprises thus far marking a 1.4 per cent year-over-year growth for the quarter. Generally speaking, the U.S. macroeconomic backdrop looks constructive with slowing yet growing GDP. The U.S. economic expansion is only a few months away from setting a new record. Here in Canada, the consensus forecast is for a more tepid GDP growth rate of 1.5 per cent for 2019.

We continue to favour U.S. equities over Canadian equities. We also like emerging markets, particularly in Asia as stimulus measures in China help consumption and economic activity in the region. However, the eventual outcome of the U.S.-China trade talks will significantly affect our allocation to this area. Lastly, we currently have no exposure to the troubled Eurozone region. Overall, we prefer companies with high-quality attributes and strong balance sheets as the global macroeconomic backdrop matures and uncertainty rises. Financials, consumer discretionary, communication services and healthcare presently serve as our largest sector weightings. Over the next several quarters, we expect a continued shift to more defensive, less cyclical and lower beta stocks in our portfolio models. Lastly, we continue to advocate an active approach and emphasize prudent stock and sector allocation.

TOP PICKS

DOLLAR GENERAL CORP (DG.N)
Last bought in January 2019 at about US$113.

Dollar General is the largest discount retailer in the U.S. with over US$25 billion in annual revenue. It offers a broad selection of merchandise, including consumables, seasonal, home products and apparel. Over 75 per cent of the company’s revenues are from recurring sales of consumables. This allows for steady revenues and earnings in any economic landscape. Dollar General’s stores are typically located in rural locations and smaller towns, areas that are off the radar of other giant mass merchant competitors. The stock currently trades at 19-times forecasted earnings, with a long-term estimated earnings per share growth rate of 11 per cent. The company’s five-year average annual adjusted return on equity (ROE) is over 22 per cent. The shares carry a below-market beta and yield a 1 per-cent dividend which is forecasted to moderately grow over the next several years

VERIZON (VZ.N)
Last bought in March 2019 at about US$55.

With over US$131 billion in annual revenue, Verizon is the top wireless provider in the U.S. It offers investors a compelling blend of income, earnings stability and long-term growth. The company’s long-term growth driver will be the launch of its 5G networks with the October launch in four U.S. cities marking its initial foray into this segment. Over time, the rise of 5G could fuel further dividend growth and multiple expansion for investors. Near-term, industry consolidation with the expected merger of T-Mobile and Sprint should provide more oligopolistic pricing power for Verizon and its major rivals in the wireless space. Verizon shares carry a low beta profile and yield a 4 per cent dividend. With interest rates holding steady and the economic backdrop maturing, large-cap telecom stocks with healthy dividends and steady earnings such as Verizon should perform well.

VANGUARD HEALTH CARE ETF (VHT)
Last bought this month at about US$167.

VHT provides investors with exposure to a diversified basket of healthcare stocks in the U.S. Top holdings include Johnson & Johnson, Pfizer, UnitedHealth Group, Merck and Abbott Laboratories. After being the top performing sector in 2018, healthcare has lagged all others year-to-date and is underperforming the broader S&P 500 by a wide margin. The underperformance has been driven by worries over potential government policies that threaten current business models. Greater political scrutiny and the potential for a future Democratic mandate calling for “Medicare for all” has weighed on investors’ minds. However, the recent weakness in the sector may provide a compelling buying opportunity. While certainly a risk, investors appear to be pricing in too great a chance of substantial government intervention. The fundamentals of the healthcare sector continue to look solid with earnings growth in the first quarter running at an 8.5 per cent rate from a year earlier. With its defensive qualities and its relative insulation from the U.S-China trade war, the sector may be poised to regain its outperformance. 

PAST PICKS: MAY 24, 2018

BANK OF AMERICA (BAC.N)

• Then: $30.21
• Now: $28.49
• Return: -6%
• Total Return: -4%

CATERPILLAR (CAT.N)

• Then: $157.70
• Now: $123.56
• Return: -22%
• Total Return: -20%

TENCENT (TCEHY.PK)

• Then: $51.83
• Now: $42.96
• Return: -17%
• Total Return: -17%

TOTAL RETURN: -14%