Jun 4, 2019

Zachary Curry's Top Picks: June 4, 2019

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Full episode: Market Call for Tuesday, June 4, 2019

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Zachary Curry, president and portfolio manager at Davis Rea
Focus: North American large caps

MARKET OUTLOOK

The global economic slowdown continues, though it’s not as severe as feared last December. Recession risk increased in late 2018, but hasn’t increased any further. Global manufacturing continues to downshift, with the automotive sector still the main source of weakness. We’re seeing some tentative signs that manufacturing activity is starting to stabilize, helped along by easier financial conditions and Chinese policy stimulus. Manufacturing activity should pick up in the second half of this year, boosting the overall global economy and underpinning rebounds in earnings growth and commodity prices. That being said, some of the recent developments surrounding trade and tariffs could push this back further.

The extreme pessimism among investors in December has given way to optimism. The key ingredient to the improved mood was the shift away from planned interest rate increases by central bankers, but especially the U.S. Fed. As with corporate bonds, we worry that sentiment has gone too far. Earnings are slowing and will slow further along with the global economy, with more downward revisions to earnings estimates. However, with economic activity expected to rebound later this year, equity markets are expected to end the year on a positive note.

Our base case view is for manufacturing activity to bottom this summer and strengthen in later 2019. The outlook for equities, corporate bonds, commodities, and the Canadian dollar is expected to improve in tandem with global manufacturing.

Downside risks are still based on U.S. interest rates, trade and geopolitical frictions. The slowdown could yet morph into recession with greater weakness in asset prices, commodities and the loonie. Alternatively, higher equity and corporate bond prices, Chinese policy stimulus, and hopefully productive U.S.-China discussions could boost confidence and bring the slowdown to an end before summer.

TOP PICKS

Zachary Curry's Top Picks

Zachary Curry, president and portfolio manager at Davis Rea, shares his top picks: JPMorgan, Brookfield Infrastructure Partners and Stryker.

JPMORGAN (JPM.N)

Despite the recent volatility in fixed income trading that has negatively affected investment banks over the last year, JPMorgan’s investment bank remains well positioned in both equity and debt underwriting and advisory. As one of the most diversified banks, it’s able to benefit from an improving U.S. economy. U.S. consumers have improved their balance sheets, and are looking to re-lever through consumer credit.

JPMorgan has been investing heavily in technology, spending US$9.5 billion to increase efficiency in legacy operations and into new investments and innovations. Due to tax reform, its effective tax rate has dropped by 10 per cent, and we anticipate increased shareholder returns coming through the form of buybacks or increased dividends (it’s yielding around 2.75 per cent).

BROOKFIELD INFRASTRUCTURE PARTNERS (BIP_u.TO)

Brookfield Infrastructure has a great track record when it comes to managing their portfolio and deploying/recycling capital. They routinely acquire interests in infrastructure companies or projects, invest capital to provide operational improvements and then sell their interest afterwards. Their global reach enables them to find value worldwide and take advantage of improving global growth in developing and emerging markets.

The company has a large backlog, with close to $1 billion being put to work in new projects over the next 24 months. Brookfield is ramping up some of the investments it’s made, integrating the Montney midstream assets from Enbridge and leveraging the Enercare assets purchased last year. They continue to recycle capital, with five other assets currently in sale processes. With infrastructure assets providing steady cash flow even in the face of rising rates and inflation (75 per cent of their revenue is indexed to inflation), Brookfield is able to grow organically and support a 4.8 per cent yield.

STRYKER (SYK.N)

Stryker is one of the world's leading medical technology companies and is active is more than 100 countries around the world. Stryker has products and services in orthopedics, medical and surgical, and neurotechnology and spine that help improve patient and hospital outcomes. Stryker continues to lead in knee surgery with their Mako robot, which has been steadily gaining share in the market as it drives better outcomes for patients and greater efficiency for surgeons. The rest of their product portfolio is performing well. They recently closed on the acquisition of K2M to bolster their spinal surgery portfolio.

Stryker has fixed many of the supply and quality issues that came with the Sage acquisition in 2017 and is returning to growth in those segments as well as their other surgical product categories. We expect the company will be able to continue to drive mid-single digit organic growth as they continue to grow faster than the market and maintain their historical capital allocation strategy of looking for opportunistic tuck in acquisitions and returning capital to shareholders (it’s current yielding 1.1 per cent).