Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

As expected, America avoided the low probability, high severity, spectre of a debt default. Relief rallying by investors who expected a dire conclusion to this political theatre, plus chronic under positioning in stocks by professional investors then triggered reflexive buying in U.S. stocks, pushing the S&P 500 to 52-week highs. Upside participation is tentatively expanding, with the equal-weighted S&P 500 slightly outperforming the traditional index in June after a remarkable 10 per cent lag year to date, through May 31. In Canada, as we approach mid-year, the S&P TSX Composite Index is little changed plus one per cent year to date, despite similar economic growth forecasts and a similar interest rate environment but valuations far below U.S. stocks. The S&P TSX Composite Index dividend yield is 2.2 times the S&P 500 yield, it trades at a 60 per cent discount to the S&P 500 on price/book measures and a 33 per cent discount in terms of its price/earnings ratio. These metrics are at or near 20-year extremes, favouring Canada. Valuation is a poor short-term timing tool but matters a lot over a decade.     

Our portfolios accordingly are 60 per cent invested in Canada versus 40 per cent in the U.S.  We’ve taken a conservative stance, emphasizing well-capitalized, high-quality, defensive businesses versus credit-dependent, discretionary and cyclical companies. Conflicting market and macroeconomic data are just about everywhere, rising interest rates coupled with homebuilder shares reaching all-time highs; semiconductor stocks soaring ever higher, despite falling industrial production; rising risk of recession, an inverted yield curve and more. Nevertheless, we are data-driven and will watch intently as these uncertainties and contradictions resolve themselves. Markets climb a proverbial “wall of worry,” and we stand ready to shift portfolios into stocks we have pre-researched and that are on standby for our proprietary “all clear” macroeconomic signal.

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TOP PICKS

Alimentation Couche-Tard (ATD TSX)

Latest purchase December 2022 at $61.85:

Alimentation Couche-Tarde is the world’s second-largest convenience store operator with nearly 13,000 stores across Canada, the United States, Europe and Hong Kong. The company earns returns on equity of 24 per cent and has grown earnings per share at a 21 per cent compound rate over the last decade. The company uses procurement scale to price sharply on fuel, drawing traffic to its sites and then luring shoppers into attractive, modern, well-merchandised stores where merchandise gross margins are three to five times higher than its profit margin on gasoline. The company is a very capable acquirer with a demonstrated pattern of realizing significant synergies from acquired businesses, in this still highly fragmented industry and recently announced a deal to acquire 2,200 stores in Germany, Holland, Belgium and Luxembourg from TotalEnergies. Its growth algorithm increasingly emphasizes organic growth, with merchandising sophistication increasing and digital marketing and loyalty programs gaining traction. This acceleration of organic growth should over time earn a higher valuation.

Constellation Software (CSU TSX)

Latest purchase August 2022 at $2,103.74

Constellation Software is a software holding company that acquires mission-critical vertical market software companies and helps them to grow. With its unique operating philosophy, Constellation equips unit operating managers with best practices, procurement and shared services efficiencies but empowers them to make decentralized decisions at the grassroots level. Notoriously and deliberately tight-lipped and non-communicative with the investment community, the company’s results do the talking for it. Earnings per share have grown at a 23 per cent compound rate over the last decade, despite operating primarily in sluggish organic growth markets. With the shares trading at 33x expected earnings, we see a good combination of value and growth here.    

UnitedHealth Group (UNH NYSE)

Latest purchase June 2023 at $460.87:

UnitedHealth Group occupies the number five slot on the Fortune 500, courtesy of its two leading businesses in health insurance and health maintenance organizations. The company is a rapid secular grower, with a compound growth rate in earnings per share of 16 per cent over the last decade, courtesy of demographic trends, morbidity trends and government policy initiatives in the United States. A recent wave of pent-up demand for elective surgeries deferred during COVID-19 by elderly patients (knees, hips, etc.) has pressured the medical cost ratios of all health insurers, including United Health. The resultant pullback in the shares to a valuation below 18x earnings afforded us an excellent opportunity to add to our long-held core position in the company.

PAST PICKS: August 30, 2022

Cameco (CCO TSX)

• Then: $38.88
• Now: $39.90
• Return: 3%
• Total Return: 3%

TD Bank (TD TSX)

• Then: $86.12
• Now: $78.06
• Return: -9%
• Total Return: -6%

American Tower (AMT NYSE)

• Then: US$253.40
• Now: US$187.34
• Return: -26%
• Total Return: -24%

Total Return Average: -9%