Zachary Curry, chief operating officer and portfolio manager at Davis Rea
Focus: North American large caps

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MARKET OUTLOOK

A broadly based and durable global economic expansion continues. We’d likely need to see a big shock to knock the economy off course and cause a major slowdown or recession. This is constructive for both corporate earnings and commodity prices. Inflation trends are likely to remain well-behaved outside of some temporary upward pressure from energy prices.

2018 began with rich valuations in corporate bond and equity markets, which made them vulnerable to risks emanating from international trade, interest rates and geopolitics. Recent weakness in equity and corporate bond prices is occurring against the backdrop of sustained economic and earnings growth, which should limit the downside for equity and corporate bond prices. Nonetheless, 2018 is likely to see more market volatility than 2017 did.

The economic and earnings backdrop remains favourable for both equities and corporate bonds, though rising government bond yields are a headwind. As long as earnings are expected to remain on a rising path, investment returns are likely to remain positive in 2018, in spite of potential bouts of volatility.

We could see more weakness ahead, but improved valuations have already created opportunities in a number of areas. U.S. banks and information technology stocks are attractive from a valuation perspective, helped along by recent U.S. tax cuts. Regulatory changes are expected to be a tailwind for U.S. banks, but could prove to be a headwind for tech companies at some point. Energy stocks are reasonably valued and should benefit from rising oil prices, especially if geopolitical risks are realized in the Middle East.

Short-term interest rates are likely to rise further in the U.S., helped along by easier fiscal policy (tax cuts and a limited amount of infrastructure spending). The Bank of Canada is likely to follow suit, but lag the Fed as NAFTA risks act as a restraint. We could see U.K. rates rise a little, but the euro area and Japanese short-term rates are expected to remain extremely low. Government bond yields are expected to drift higher, favouring short-term bonds over longer-term issues.

TOP PICKS

JPMORGAN CHASE (JPM.N)
Most recent purchase: Feb. 1, 2018 at US$116.52.

JPMorgan Chase provides global financial services and retail banking to institutions and individuals. It is the largest bank holding company in the U.S. and top 5 in the world, with more than 5,000 branches in America. It’s also one of the U.S.’s top mortgage lenders and credit card issuers and has strong investment banking and asset management operations, with more than US$2.5 trillion under management.

JPMorgan recently released positive fourth-quarter 2017 results. We believe the company is well-positioned to benefit from rising interest rates in the U.S., increased consumer spending (and borrowing) and the recent legislation that was passed reducing tax rates going forward. We believe that JPMorgan will return more capital to shareholders over time – both through dividend increases (the shares currently yield 2 per cent) and share re-purchases (the company re-purchased US$4.7 billion of shares in Q4/17).

BROOKFIELD INFRASTRUCTURE PARTNERS (BIP_u.TO)
Most recent purchase: Feb. 6, 2018 at $51.83.

Brookfield Instructure Partners owns and operates infrastructure assets such as utilities, toll roads, pipelines, network towers and ports globally. It has a great track record when it comes to managing their portfolio and deploying and recycling capital. They routinely acquire interests in infrastructure companies or projects, invest capital to provide operational improvements and then sell its interest afterwards.

Their global reach enables them to find value worldwide and take advantage of improving global growth in both developing markets (Canada, U.S. and Europe) and emerging markets (Brazil, China and India). They recently sold their interest in their Chilean electricity transmission asset, and have committed to acquiring the second-largest natural gas distribution system in Colombia. They have a large backlog of projects, with close to $1 billion being put to work in new projects over the next 24 months.

With infrastructure assets providing steady cash flow even in the face of rising interest rates and inflation (75 per cent of their revenue is indexed to inflation), Brookfield Infrastructure is able to grow organically and support the 4.7-per-cent yield on the stock.

KELT EXPLORATION (KEL.TO)
Most recent purchase: Feb. 9, 2018 at $6.91.

Kelt is an oil and gas company that focuses on exploration, development and production of crude oil and natural gas primarily in Northwestern Alberta and Northeastern B.C. It recently released its year-end reserve report, with proven and probable (P&P) reserves growing at 20 per cent year-over-year and production and cash flow coming in above estimates.

Based on Q4/17 production, Kelt has a proved developing producing (PDP) reserve life index of four years and a P&P reserve life index of more than 25 years. The company recently disposed of its Karr assets and is positioned very well financially, with debt-to-cash flow of only 1.1 times compared to its peers at 2.3 times. Recent well results at Fireweed were promising and will be key in de-risking the northern portion of its land holdings with more well locations.

PAST PICKS:  MARCH 16, 2017

FACEBOOK (FB.O)

• Then: $139.99
• Now: $179.52
• Return: 28.23%
• Total return: 28.23%

STRYKER CORP (SYK.N)

• Then: $131.50
• Now: $156.24
• Return: 18.81%
• Total return: 20.28%

ALTAGAS - SUBSCRIPTION RECEIPTS (ALAr.TO)

• Then: $29.74  
• Now: $26.27
• Return: -11.66%
• Total return: -5.58%

Total return average: 14.31%

FUND PROFILE

Davis Rea Equity Fund
Performance as of Feb. 28, 2017

• 1 Month: -0.6% fund, 1.8% index
• 1 Year: 12.9% fund, 21.2% index
• 3 Year: 2.7% fund, 6.0% index

* Index: 50% S&P/TSX 60 Index, 50% S&P 500 Index
* Returns only gross of fees and reinvested dividends

TOP 5 HOLDINGS AND WEIGHTINGS

• U.S. dollar cash - 9.8%
• Tourmaline Oil - 8.5%
• Alphabet Inc (Class A) - 8.2%
• AltaGas (Subscription receipts) - 7.9%
• Kelt Exploration - 7.7%

TWITTER: @DavisRea
WEBSITE: www.davisrea.com