John Zechner, chairman and founder at J. Zechner Associates Inc.
Focus: North American large caps
Global economic growth remains weak, profit margins have peaked for this cycle and input costs, most noticeably wages, are starting to rise again. Stocks are still trading near record valuations but are losing support from interest-rate comparisons as rates rise on fears of higher inflation. Trump’s “tough on trade” and “return to growth” election promises will be hard to realize. Globalization has reduced manufacturing costs and expanded markets for many firms in consumer products, industrials and technology over the last decades and those gains are at risk if global trade deals and immigration are threatened and companies are forced to move manufacturing back to the U.S. where costs are higher, productivity is lower and the work force is older and not growing. Higher interest rates will lessen the “TINA” arguments for stocks as they provide safer, more attractive alternatives. We have seen bear markets in stocks early in most presidencies. While initial reaction has been extremely bullish, we now see greater risks to global economic growth at a time when earnings growth is negligible and stock valuations are high. We are cautious on the outlook for stocks and are reducing positions in the financial and materials sectors. Declining growth differentials between the U.S. and global economy should lead to a peak in the U.S. dollar. This would provide some strength to the gold and materials sectors and we see some opportunities there, as well as in U.S. technology stocks, due to their relatively attractive valuations and long-term growth.
MARTINREA INTERNATIONAL (MRE.TO) – Last purchased at $6.90 in November 2016
Stock trading at lowest valuation of group but expecting less than 10 per cent earnings growth per year, over next three years, as recent spending is used to roll out new programs to yield results. Profit margins are expanding as these new growth platforms are more fully utilized and margins continue to rise. There’s excess cash generation also being used to significantly reduce financial leverage. The company also has the best exposure in the industry to the increasing use of aluminum in autos, which is a substantial ongoing trend to lower overall production costs and operating efficiencies. The sector valuations are exceptionally low (already pricing in the next recession), as investors worry about “peak auto” sales, in addition to the negative impact from Trump’s threats to force auto companies/suppliers to move production back to the U.S. The average age of autos in North America remains near a record high and auto spending is tied to growing employment levels, suggesting less of a downturn than investors are worrying about.
SHORT: CATERPILLAR INC. (CAT.N) – Last sold at US$98 in January 2017
The stock is trading at over 30 times earnings despite missing estimates and guiding lower again. There’s little growth expected in 2017, as global capex/mining spending is slowing and there is a glut of equipment on the market. CAT has started selling their own used equipment on their website and prices have been falling at five per cent annual rate. Investors are far too optimistic about the impact of U.S. infrastructure spending for CAT. The stronger U.S. dollar is also a headwind. Multiple on 2017 earnings are higher than that of Facebook, which seems disconnected, given such differing growth rates. A more conservative strategy would be to hedge this short sale trade with an offsetting long position in a more reasonably priced industrial stock such as CP Rail.
FACEBOOK INC. (FB.O) – Last purchased at US$118 in November16
With almost 1.8 billion monthly active users, Facebook is the largest beneficiary of the advertising shift from television to online advertising. Mobile revenues have risen from basically zero three years ago to 84 per cent of last quarter’s US$7 billion in revenue. Operating margins continue to expand, allowing faster earnings growth. In Facebook’s last quarterly report, engagement metrics expanded across the board, including mobile daily active users up 22 per cent to over 1.0 billion for first-time users. Revenue growth of 56 per cent beats street estimates again. The stock is trading at only 23/19 times 2017/2018 consensus earnings estimates and only slightly higher multiple when adjusted for stock-based compensation. Facebook is the best large cap growth story in technology.
PAST PICKS: FEBRUARY 16, 2016
CGI GROUP (GIBa.TO)
- Then: $56.58
- Now: $64.02
- Return: 13.14%
- TR: 13.14%
FREEPORT MCMORAN (FCX.N)
- Then: $6.37
- Now: $15.69
- Return: 150.55%
- TR: 150.55%
MANULIFE FINANCIAL (MFC.TO)
- Then: $16.63
- Now: $24.59
- Return: 47.87%
- TR: 53.83%
TOTAL RETURN AVERAGE: +72.50%
FUND PROFILE: J ZECHNER ASSOCIATES GLOBAL HEDGED GROWTH FUND
PERFORMANCE AS OF JANUARY 31, 2017:
- 1 month: Fund -1.0%, Index* -0.3%
- 1 year: Fund +7.5%, Index* +15.0%
- 3 years: Fund +11.0%, Index* +3.0%
- 5 years: Fund +8.4%, Index* +2.5%
* Index: GlobeFund Alternative Strategies Index
TOP HOLDINGS AND WEIGHTINGS
- Short – SPDR Trust Unit Series 1 (ETF for S&P500): 58.4%
- Short – Caterpillar Inc.: 15.0%
- Long – Detour Gold Corp: 6.7%
- Short – Deere & Co.: 6.7%
- Short – Bank of America: 5.4%