John Zechner, Chairman & Founder, J. Zechner Associates

Focus: North American large cap stocks

Top picks: Rogers Communications, B2Gold, Pembina Pipeline

MARKET OUTLOOK:

We are cautious on the outlook for stocks and have reduced equity weights to the low end of our designated ranges for clients. We believe investors are too complacent about the risks from tariffs to economic growth and profits. Tariffs have yet to be fully reflected in economic or earnings data, but we are starting to see it more in some recent profit reports from major players such as General Motors, CN Rail and Texas Instruments.

We don’t expect any retraction of tariffs and that will be a headwind for capital spending and employment as companies can’t make major moves amid this uncertainty. We have already started to see that in terms of recent employment numbers, capital spending plans as well as housing data. We also have concerns over both valuations and sentiment indicators, which are back to where we were before “Liberation Day” with inflated forward earnings multiples and excessive levels of bullish market sentiment.

Trailing earnings are back at record highs of 26 times with only a five per cent run-rate of earnings growth this quarter. Meantime, sentiment indicators such as the retail AAII, Investors Intelligence or B of A surveys have all recovered from April lows and are back to levels seen at the late 2021 market peak.

While sentiment and valuation aren’t enough to bring on a stock downturn, they can add to volatility on the downside when we start to see weaker economic and earnings numbers from the rollout of tariffs. Investors saw how quickly sentiment can change and markets can fall earlier this year.

In terms of strategy, we moved to more defensive sectors, with continued overweight positions in the telecom, consumer staple, utility and pipeline sectors. Within energy we have sold producers and moved to the pipeline sector, effectively moving to stocks that are “volume dependent” rather than “price dependent.”

We continue to have a strong weight in the tech sector since we expect they will continue to demonstrate the best earnings growth, amplified by the robust spending on building and rolling out AI models. We have also added to long-term bond holdings in both Canada (3.8 per cent yield) and the U.S. (4.9 per cent long term Treasury yield). We see bigger risks to economic growth than to inflation from the increased tariffs and expect that long-term interest rates will head lower again as central banks move back to easier money.

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TOP PICKS:

Rogers Communications (RCI.B TSX)

Telecom stocks have been massive underperformers for the last few years as the entry of a fourth wireless player (Freedom Mobile) and tighter restrictions on immigration lead to pressures on margins and subscriber growth in wireless. This impact seems to have bottomed recently at the same time as the stock is trading at multi-year valuation lows (less than seven times earnings before interest, taxes, depreciation and amortization [EBITDA].

Investors were also worried about excessive debt levels from the Shaw acquisition, but they are now generating free cash flow to pay down that debt. We also expect monetization of their sports franchises (Maple Leaf Sports & Entertainment [MLSE] plus Toronto Blue Jays and Rogers Centre) as these assets have reached world class asset size at a time when valuations in the industry have surged.

B2Gold (BTO TSX)

We believe that there is further upside in both the price of gold (from a weak U.S. dollar and ongoing central bank buying) and gold stock valuations. B2Gold stands out as one the better risk-reward plays since their valuation has been depressed over worries about the geo-political risks of their largest producing mines (Fekola in Mali and Otjikoto in Namibia). While those risks remain, they are also adding new mines in less controversial geographic regions including Gramolote (Colombia) and Goose (Nunavut) while also expanding the resource at Fekola, where they signed a long-term production sharing agreement with the ruling government in Mali. We expect the valuation discount to narrow as Goose and Gramolote come into production.

Pembina Pipeline (PPL TSX)

We see energy infrastructure having the best growth profile over the next few years as Canada increases its reach to foreign markets to diversify away from the U.S. market. Pembina is a leading energy transportation and midstream service provider that owns an integrated network of hydrocarbon liquids and natural gas pipelines, gas gathering and processing facilities, oil and natural gas liquids infrastructure and logistics services, and an export terminals business. The stock has lagged the group due to concerns about pricing on the Alliance Pipeline such that it now has the lowest valuation in the group along with a 5.2 per cent dividend yield and the high growth potential to expand gas transport on an East-West basis. They are also positioned to benefit from the growth in LNG through their 49 per cent ownership of the Cedar liquefied natural gas (LNG) facility.

PAST PICKS: JUNE 28, 2024

MDA SPACE (MDA TSX)

Then: $13.66

Now: $41.49

Return: 204%

Total Return: 204%

Capital Power (CPX TSX)

Then: $38.99

Now: $63.24

Return: 62%

Total Return: 69%

TOREX GOLD (TXG TSX)

Then: $21.20

Now: $42.84

Return: 102%

Total Return: 102%

Total Return Average: 125%