Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

Upside participation in U.S. markets is tentatively expanding, with the equal-weighted S&P 500 slightly outperforming the traditional index since the end of May after a remarkable 10 per cent lag through the first five months of the year. Our portfolios are conservatively positioned, with an emphasis on well-capitalized, high-quality businesses rather than credit-dependent, or deeply cyclical companies. We also are finding more opportunities in Canada, so our portfolios accordingly are 60 per cent invested in Canada versus 40 per cent invested in the U.S. The S&P TSX Composite Index dividend yield is 2.2 times the S&P 500 yield. It also trades at a 60 per cent discount to the S&P 500 on price/book measures and a 33 per cent discount in terms of its price/earnings ratio. These metrics are at or near 20-year extremes, favouring Canada. Valuation is a poor short-term timing tool but matters a lot over a decade.     

Conflicting market and macroeconomic data are just about everywhere. This includes rising interest rates coupled with homebuilder shares reaching all-time highs, semiconductor stocks soaring ever higher, despite falling industrial production, rising risk of recession, an inverted yield curve and more.

Nevertheless, corporate earnings – not macroeconomic conditions and variables - are the most important driver for a company’s share price over the long term. As a result, our team is quite busy at this time every quarter poring over details of financial results for companies that we own and those that we’d like to own. We’re finding and acting on opportunities in technology, health care and industries, among other areas in recent weeks.

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TOP PICKS

Northrop Grumman (NOC NYSE)

Latest purchase July 2023 at $459.54:

Northrop Grumman is one of five American “prime” defense contractors, an industry which is a “moat” oligopoly with very predictable and stable revenues stemming from long-running programmes with their primary customer, the United States government, which comprises 86 per cent of sales and underpins most of its $80 billion backlog. The company sells products and services in four segments; space systems, aeronautics systems, mission systems and defense systems. The shares have stabilized over the past six months after pulling back 23 per cent from its peak late last year. This occurred while government debt ceiling concerns were front and centre as the company grinds through a $1.2 billion cost overrun on the fixed price B-21 bomber contract that is pressuring earnings growth in 2023. A big catalyst in 2024 is the expected award of the Next Generation Air Dominance contract (successor to the F-22 fighter jets, which have been in service for 25 years), with expected funding of $16 billion, and Northrup Grumman likely to be involved in that contract.

Shopify (SHOP TSX)

Latest purchase Jul 2023 at $87.89

Shopify offers e-commerce enablement services primarily to small/mid-size enterprises via a recurring subscription model and ancillary merchant solutions such as payments, working capital financing, shipping and more. E-commerce continues to benefit from long-term secular tailwinds, but in the near term, Shopify specifically should also benefit from renewed earnings momentum with the recent divestiture of its fulfillment business, which was a strategic mistake and a big drag on profitability. Some recent new arrivals in its C-suite and boardroom have helped to refocus Shopify’s strategy on profitability and growth. For reference, consensus estimates forecast an +800 per cent improvement in profit this year in light of the meaningful workforce reduction and the elimination of the large fulfillment centers.

Brookfield Corp. (BN TSX)

Latest purchase May 2022 at $61.39

Brookfield is among the world’s foremost managers and operators of long-duration real assets like real estate, private equity, infrastructure, renewable energy, and utilities with deep expertise in sourcing transactions and surfacing value. With significant assets in Canada, the United States, the U.K., Australia, Brazil, and India among other areas; the company has tremendous reach and geographic diversity. Brookfield’s size and scale allow it to field expert teams with deep operating experience across industry verticals and geographic areas. Moreover, its financial strength and variety of funding sources afford it the advantage of being among the first calls sellers of world-class assets make when looking to consummate a transaction. Flows into alternative assets are outstripping flows into stocks and bonds, as institutions like pension funds increase allocations to these less efficient markets which better match long-duration liabilities. Accordingly, Brookfield enjoys consistently strong inflows and now manages over $825 billion. The company has generated a compound annual return for shareholders of 15 per cent over the last twenty-five years, such that $1 invested in its shares is now worth over $32, courtesy of these many structural advantages. 

PAST PICKS: October 4, 2022

NextEra Energy (NEE NYSE)

• Then: $82.82
• Now: $75.67
• Return: -9%
• Total Return: -7%

Stella-Jones (SJ TSX)

• Then: $40.62
• Now: $68.07
• Return: 68%
• Total Return: 70%

Albemarle (ALB NYSE)

• Then: $283.78
• Now: $216.41
• Return: -24%
• Total Return: -23%

Total Return Average: 13%