Cameron Hurst, chief investment officer of Equium Capital Management
Focus: U.S. equities

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MARKET OUTLOOK

Among the many benefits of using two lenses in an investment process, we find our technical analysis has a natural tendency toward capital preservation. For example, several positions in the fund were exited in January and early February on technical breaks before the market fell out of bed and into this volatile consolidation. Going into this difficult period with elevated cash reduced volatility in the fund and the total drawdown.

Equium Capital’s view of risk assets and equity markets consistently struck a neutral tone over the last few Market Call shows and nothing has changed from the top-level view. We see the S&P 500 Index in a range between about 2,800 and 2,575; however, we note sector performance has been far more selective.

Equities continue to have a pro-cyclical bias, with technology, financials and consumer discretionary leading, while bond proxy sectors like consumer staples, telecom, utilities and real estate have lagged with including the recent safety trade.

Accounting for conditional factors like bond spreads, market breadth, advance/decline lines, put-call ratios and over-bought/over-sold signals, we remain positively biased toward risk assets in the medium term. But we also remain cautiously positioned with elevated cash until the market breaks out properly from this consolidation range.

Internationally, we observe more meaningful sector rotation in Europe, which may portent reduced upside on the continent. The euro being 16 per cent higher versus a year ago certainly puts a crimp in exports for regional leader Germany, but France continues to demonstrate good leadership and remains our sole explicit country exposure in the region.

Unfortunately, the tail risk of President Trump facing direct legal action increased this week when the offices of his personal lawyer were raided by the FBI. But this is likely to take considerable time to play out, making immediate tactical positioning inappropriate. We remain alert to the risks and ready to act if and when more tangible information comes to light on this front.

Lastly, energy is grabbing headlines as WTI races towards $70. We remind investors that U.S. output is likely to accelerate (the rig count jumped again last week) and Russian sanctions add to the likelihood of an increased output to raise much-needed funding. Accordingly, we do not see this as a one-way trade, notwithstanding the comments from Saudi Arabia about $80 oil on the horizon.

TOP PICKS

Cameron Hurst's Top Picks

Cameron Hurst, chief investment officer at Equium Capital Management, shares his top picks: the iShares US Medical Devices ETF, the iShares US Broker-Dealers and Securities Exchanges ETF and the Consumer Discretionary Select Sector SPDR Fund..

ISHARES US MEDICAL DEVICES ETF (IHI.US)

POSITIVE – Stable end market fundamentals and new product launches in 2018 should boost revenues.

  • The group is exposed to a number of positive secular trends: aging population, the obesity epidemic emerging market demand.
  • Medtech revenue growth likely reaccelerates in 2018 (to 5.1 per cent from 4.4 per cent in 2017), driven by new product launches in 2018 on the back of strong 2017 new device approvals (especially in the U.S).
  • Channel checks demonstrate stable end markets (cardio, ortho) with respect to volumes and pricing.
  • Worldwide hospital capital spending trends strong, as political uncertainty around the Affordable Care Act has decreased and private capital spending in China picks up.
  • Expect a tailwind in Q1/18 from a weak U.S. dollar. It should amount to around 3 per cent in revenue growth.
  • Expect a tailwind in the H2/18 from easy comps given hurricane disruption 2H17.
  • Tax reform provides access to overseas cash (77 per cent large cap cash outside of the U.S.) and flexibility to undertake M&A.
  • A medical device tax overhang has been removed, with the tax suspended until 2020.
  • There’s limited potential impact from the China tariffs. If implemented, the worst-case scenario to the global medtech market is a $1.5-billion hit (the market is nearing $400 billion). If China retaliates, only 8.5 per cent of U.S. medtech’s exports are to China.
  • Little to no Amazon risk as it’s not likely that Amazon can penetrate the medical device market because of the complex value-added service these companies offer.
  • The group trades at premium to the market. Medtech offers stability in a volatile market and given investors ’ less favorable view of most other health care subsectors, this premium could be maintained or even increase.

ISHARES US BROKER-DEALERS & SECURITIES EXCHANGES ETF (IAI.US)

POSITIVE – There are strong cyclical tailwinds and multiple drivers of top-line growth for IAI.

  • Tax reform can be a powerful, although short-term driver of EPS growth.
  • Regulatory reform has a longer runway and broader financial sector implications, positively impacting both the credit-sensitive lenders as well as the more rate-sensitive industries.
  • Within the financials sector, the IAI positively focuses on the combination of securities exchanges with the capital markets players like Morgan Stanley and E*TRADE Financial.
  • On securities exchanges:
    • Their lower volatility adds ballast to the ETF because they generate significant revenues from stable and recurring sources, like data.
    • There’s some element of counter-cyclical revenue because they also benefit from higher exchange volumes, which tend to occur during market stress.
  • On capital markets:
    • Larger firms like Morgan Stanley now generate half their revenue from wealth management, which is more stable than the tradition trading and syndication businesses.
    • Adding to their appeal, wealth management businesses, discount brokers like Charles Schwab and E*TRADE Financial, and trust banks carry huge deposit balances that haven’t been contributing to the bottom line when rates were zero. As rates rise, these institutions can earn a spread on the balances, so they’re hugely interest-rate sensitive.

CONSUMER DISCRETIONARY SELECT SECTOR SPDR FUND (XLY.US)

POSITIVE – we have recently moved overweight discretionary, as the sector has technically broken out of its downtrend and the companies broadly benefit from several fundamental tailwinds.

  • A recent 10 per cent pullback has provided a compelling entry point for a group of high-quality consumer names including Home Depot, Comcast, Disney, Nike and McDonald’s.
  • Tax reform and a better-than-expected holiday season not only helped to drive sector earnings revisions higher, but also provided a significant boost to cash flow giving companies capacity to increase necessary e-commerce and related investments while also returning cash to shareholders.
  • Wage growth is a double-edged sword as stronger revenue is somewhat offset by higher costs, but many of the large caps have limited to no exposure to labour, so they’re clear net beneficiaries.
  • We see Trump-Amazon headlines (20 per cent of index) as noise and Facebook’s data and privacy issues as largely unrelated so that the 15 per cent pullback will likely prove an attractive entry point for the most compelling e-commerce and cloud storage names in the market.
  • Other top holdings should benefit from a variety of tailwinds, such as a tight housing market (Home Depot, Lowe’s), media consolidation and increased value of content (Comcast, Disney, Fox, Time Warner and Netflix) and e-commerce (Amazon, Booking Holdings).
  • Risks would include a recession as well as a spike in interest rates, which would pressure consumer budgets.

 

DISCLOSURE PERSONAL FAMILY PORTFOLIO/FUND
IHI N N Y
IAI N N Y
XLY N N Y

 

PAST PICKS: MAY 17, 2017

Cameron Hurst's Past Picks

Cameron Hurst, chief investment officer at Equium Capital Management, reviews his past picks: Abbott Labs, Alphabet and Visa.

ABBOTT LABS (ABT.N)

POSITIVE – Abbot is a diversified health care company with exciting pipeline in 2018. Its segments are: medical devices, diagnostics, nutritionals and pharma.

  • A solid second half of 2017 for product approvals sets Abbott up for very strong 2018, with organic growth expected to reach the high end of 6 to 7 per cent. They saw product approvals in cardio (MRI-safe pacemaker), diabetes (Free Style Libre) and diagnostics (Alinity Lab System).
  • The company is seeing solid growth for their innovative Free Style Libre glucose monitoring product, which eliminates the need for finger prick and can monitor levels on a continuous basis. Libre was launched in Q4/17 and helped Diabetes Care grow at 7 per cent in that quarter versus a 13 per cent decline in Q3/17.
  • Its Alere acquisition last October makes Abbott a leader in point-of-care diagnostics and increases access to new sales channels (clinics, home testing) and overseas markets (Europe). It’s expected to be 10-cents accretive to earnings per share (EPS) in 2018.
  • The St Jude acquisition in early 2017 is highly complementary ($0.21 accretion) as it broadens Abbott’s business in the high-growth cardiovascular area.
  • Expect continued robust growth at pharma segment, driven by ongoing emerging market penetration (emerging market equates to 80 per cent of pharma revenues).
  • There’s room for EPS upside coming from the company’s ability to access US$8 billion in overseas cash after the tax reform and pay down debt.
  • The stock is trading at 20.7 times 2018 EPS marginally above large cap average of 19.3 times. The premium is justified given Abbott’s upcoming 2018 product cycle, expected cost synergies from the Alere and St Jude acquisitions, and strong end markets.

 

  • Then: $43.08
  • Now: $58.67
  • Return: 36%
  • Total return: 38%

ALPHABET (GOOGL.O)

POSITIVE– We remain neutral technology as relative performance has flattened out and risks have increase, but we do like the internet and software subsectors.

  • Google continues to execute against multiple compelling opportunity sets that are driving significant 20 per cent plus revenue growth (Q4/17 32nd straight quarter with more than 20 per cent), though TAC (traffic acquisition costs) and “other bet” investments continue to modestly weigh on earnings growth.
  • Core advertising business continues to be strong (up 21 per cent year-over-year in Q4/17; 66 per cent of ad spend still offline). Google Sites up 24 per cent. Secular digital ad growth and mobile usage highly likely to continue driving superior earnings growth on their own and Google has about 70 per cent market share of global search ad revenue.
  • Beyond the core, cloud services are growing rapidly with significant opportunity ahead (and within an oligopoly with Amazon and Microsoft). Q4/17 was the first disclosure of cloud financial metrics, with management stating that it’s currently a $4-billion annual revenue run rate business, which is higher than street expectations and growing faster than peers.
  • Machine learning, AI and autonomous driving are also significant initiatives for Alphabet, but with uncertain future. Waymo is over four million miles of real driving time. Google Assistant is on 400 million devices. Lots of high-level commentary, but investors are getting tired of the lack of financial details.
  • YouTube up to 1.5 billion monthly users and 60 minutes per day average. Critically, ad viewability rate is 95 per cent compared with 66 per cent average for video ads.
  • Management attempting to get “other bet” spending under control (paused Google Fiber expansion), which should reduce the current $4-billion drag on operating income (around 10 per cent of total). Fiscal year 2017 was down to a still sizable $3.6-billion loss so progress is directionally positive, but not really in magnitude.
  • Significant international exposure (53 per cent of sales) could be helped by tax repatriation holiday ($96 billion cash, 13 per cent of cap).
  • Valuation of 20 times is roughly in-line with long-term averages (21 times) and remains below historical relative premium to S&P (current 135 per cent versus average 153 per cent).
  • $2.7-billion fine from EU raises concerns that Google anti-trust attention is beginning to pick up and could weigh on the future outlook. FB’s privacy scandal could also easily have knock-on effects on Google’s businesses, but congressional support for sweeping regulation in the U.S. remains fairly muted for now.
  • In sum, we like the company and the array of addressable opportunities trading at a reasonable price. Further “other bet” disclosures could be a material positive catalyst. But margin weakness (TAC) and increased anti-trust attention will need to be watched carefully.
     
  • Then: $942.17
  • Now: $1,020.90
  • Return: 8%
  • Total return: 8%

VISA (V.N)

POSITIVE – As technology and spending patterns evolve, we really like the fintech and payments space in general.

  • Visa bought in Visa Europe, so it’s a more complex company now, with foreign exchange and currency headwinds/tailwinds.
    • Reorganization started last quarter and is helping to modestly reduce the corporate tax rate.
  • Management continues to post beat-and-raise quarterly results, a consistency we really like.
    • It keeps a raised guidance each earnings release.
    • The volume trends are stable, with double-digit year-over-year growth and improvement in cross border volumes and transactions.
    • Operating margin came in mid-to-high 60s last quarter. Visa has almost 10 per cent higher operating margin over the last 12 months versus Mastercard.
  • Visa volumes remain stronger than Mastercard.
  • Total U.S. volumes, U.S. purchase volumes, EU purchase volumes all consistently higher over than MasterCard’s due to several major partnership wins.
  • You’re getting approximately the same growth out of Visa at 2 to 3 price-to-earnings points cheaper valuation.
  • Visa’s management is focused on capital return, with dividends and share repo over 100 per cent of net income.
  • It’s not cheap, but it’s a high-quality duopoly franchise in an industry with very high barriers to entry, big margins and a long growth runway.

 

  • Then: $91.76
  • Now: $120.78
  • Return: 32%
  • Total return: 32%

Total return average: 26%

 

DISCLOSURE PERSONAL FAMILY PORTFOLIO/FUND
ABT N N Y
GOOGL N N Y
V N N Y

 

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