Full episode: Market Call for Thursday, February 15, 2018
John Zechner, Chairman and Founder, J. Zechner Associates
Focus: North American Large Caps
One of the reasons 2017 was a good year for the markets was because the economy accelerated globally. There continue to be signs of sustainable growth with none of typical recession indicators present, so this economic momentum should continue for a while and support further earnings growth, which will be boosted even further in the U.S. by the recent tax cuts. Europe, Asia and the Emerging Economies are also experiencing strong recoveries, due mainly to the lagged impact of all the monetary easing (zero interest rates do eventually work). However, not unlike conditions in 1987, stocks are already reflecting most of this optimism as valuations remain at historically high levels, investor sentiment is near record bullishness, cash levels are at cyclical lows and monetary ease, the prime driver of the stock market gains, is slowly being removed. Recent stock price weakness is due to fears that interest rates may rise at an even faster level due to the recent tax cuts, massive spending programs and increased government borrowing. The U.S. is effectively ‘adding fuel to the fire’ by pushing aggressive ‘pro-growth’ policies at a time when unemployment is at a multi-decade low and inflationary and wage pressures are starting to build. Adding risk to the downturn in stocks could be the plethora on new passive investing products created during this bull market and the impact of this money on the volatility in any downturn.
This is not unlike the way ‘innovative’ mortgage products in 2005-07 helped create the housing bubble and then also lead to its ultimate demise. While economic fundamentals and earnings growth should provide support for stock prices, the impact of higher interest rates, high valuations and excessive investor sentiment will create more market volatility this year, not unlike the volatility seen for the few months following the 1987 stock market crash. We are advocating somewhat higher levels of cash (for liquidity and safety) and a shift from ‘growth’ to ‘value’ stocks, which would benefit more from global economic growth and higher interest weights. We zero or underweight positions in the defensive and interest rate sensitive sectors of the stock market and overweight cyclical groups such as energy, basic materials, industrials and financials. We continue to be overweight large global technology stocks for their continued growth and moderate valuations.
OPEN TEXT (OTC.TO) - Most recent buy at $43, Jan/18
The company is augmenting traditional strong growth from acquisitions with organic growth as it consolidates recent acquisitions (Documentum, Guidance, Covisant), expands their client list and ‘cross-sells’ their product suite in the enterprise space. Cloud revenue growth beating expectations and leading to more stable earnings growth vs licence-based model and should also improve stock trading multiple. Free cash flow generation is huge and is being used to pay down acquisition debt and allow for further acquisitions. Gross margins have also been increasing, leading to higher cash flow. Valuation is only 13 times expected forward earnings and 10 times EV/EBITDA, a substantial discount to comparable names in the sector.
QUALCOMM (QCOM.O) - Most recent buy at US$62, Feb/18
See upside from multiple sources. Broadcomm bid of US$82 is being evaluated by QCOM and could lead to higher ‘friendly’ deal. Earnings upside from NXP Semi acquisition if it is accepted. Currently no earnings from various parts of QTL business as Chinese manufacturers hold back royalty payments and disputes with Apple continues. Any resolution of either issue would lead to earnings upside. Also, they remain positioned as undisputed leader in smartphone market for further gains as the world moves to 5G. Stock is trading at only about 16 times next year’s earnings assuming none of these issues are resolved.
VANECK VECTORS OIL SERVICES ETF (OIH.N) - Most recent buy at US$24.50, Feb/18
The biggest beneficiaries of oil prices holding above US$60/bbl should be the U.S. energy service stocks and this ETF contains a diversified basket of the largest names in the industry, with Halliburton and Schlumberger accounting for over 35% of the Fund. Fourth quarter earnings reports from both of those companies beat expectations and projecting strong growth this year as U.S. and global producers put excess cash generation from recovering oil prices into spending on existing and new projects. Energy service stocks continue to trade well below replacement value, a historically good metric for identifying buy and sell points in this industry. Technical picture on this ETF also looks attractive as it bounces off multi-year low at US$22, but remains well below cycle high of over US$56 in 2014.
PAST PICKS: February 13, 2017
MARTINREA INTERNATIONAL (MRE.TO)
- Then: $8.70
- Now: 14.73
- Return: 69.31%
- Total return: 71.07%
- Then: US$134.05 %
- Now: US$177.05
- Return: 32.08%
- Total return: 32.08%
***SHORT*** CATERPILLAR (CAT.N)
- Then: US$98.50
- Now: US$158.12
- Return: -60.52%
- Total return: -64.73%
Total average return: 12.80%
JZ Canadian Union Partnership Fund
Performance as of: December 31, 2017 (Provided by GlobeFund)
3 Month: +3.25 Fund, +2.77% Index*
1 Year: +12.92% Fund, +5.60% Index*
2 Year: +14.05% Fund, +6.26% Index*
* Index: Globefund Neutral Balanced Index
* Fund returns are not based on reinvested dividends. Returns provided ARE net of fees!
Top five holdings and weightings
Canadian Pacific Rail – 5.44%
Martinrea International – 4.24%
Suncor Energy – 4.00%
SNC Lavalin Group – 3.82%
Maxar Technologies – 3.51%