Gavin Graham, chief investment officer, SmartBe Investments

MARKET OUTLOOK:

The decision by the Bank of Canada to raise interest rates last week by 0.25 per cent to 4.75 per cent, the highest since 2001, shows its pause earlier this year was just that, a pause. The U.S. Federal Reserve’s decision to pause (or skip) an increase this week from five per cent similarly does not mean it’s finished raising rates. While the headline consumer price index (CPI) is falling (to four per cent from 4.9 per cent in the U.S.) due to food and energy price increases after the invasion of Ukraine dropping out, core CPI remains well above the two per cent target.

The stock market has chosen to ignore the sharply inverted yield curve (4.75 per cent for two-year bonds versus 3.75 per cent for 10 years). The yield curve has an infallible record as a predictor of recession, with the S&P 500 up 20 per cent from its low in October and the Nasdaq up 30 per cent. The increase has been extremely narrow and concentrated in mega-cap technology stocks, the FAANG+s plus Tesla and Nvidia, the latter driven by AI enthusiasm. The rest of the 490 stocks in the index are flat for the year.

Investors should maintain exposure to dividend-paying defensive sectors with sound balance sheets, which have lagged over the last few months. This includes utilities, pipelines, telecoms, financials (the Canadian banks’ valuations are the cheapest since the financial crisis) and selected real estate investment trusts while increasing exposure to energy and materials, off 10-20 per cent over the last year on recession worries. This makes Canada look more attractive than the U.S.-it’s certainly a lot cheaper.

• Sign up for the Market Call Top Picks newsletter at bnnbloomberg.ca/subscribe
• Listen to the Market Call podcast on iHeart, or wherever you get your podcasts

TOP PICKS:

Lundin Mining (LUN TSX)

Lundin Mining is a Canadian base metals mining company producing copper (65 per cent), nickel (15 per cent), zinc (15 per cent) and gold (five per cent). Production is from mines in the U.S. Chile, Brazil, Argentina, Portugal and Finland with US$3 billion in revenues in 2022. It has recently bought 51 per cent of the Caserones copper mine in Chile for US$800 million, nearby its main Candelaria mine, which will increase its copper output by 50 per cent. The growth in EV demand (each EV needs three to four times the copper in a conventional auto) will support copper prices for the next decade or more. Sells at a P/E of 15 times 2022 earnings and a 3.6 per cent yield.

Watts Water Technologies (WTS NYSE)

Watts Water Technologies is a leader in the supply of plumbing, heating and water filtration systems with sales of US$2 billion in 2022, which gives it 12 per cent of the global market. With the focus on infrastructure replacement and repair (60 per cent of revenues) and with continued growth in new construction (40 per cent), Watts has continued steady growth for the next few years and its high margins of 16 per cent support its P/E of 23 times.

Bank of Nova Scotia (BNS TSX)

The most internationally oriented of the big banks, with 30 per cent of its earnings from the four Pacific Alliance countries of Mexico, Colombia, Chile and Peru, Scotia has been the laggard amongst the Big Six, partially due to these earnings being lower rated. Usually the lowest cost operator, and with a major asset management division which has been negatively affected by the bear market in 2022, Scotia sells for a P/E below 10 and has a 6.4 per cent dividend yield.

PAST PICKS: February 28, 2023

Agnico Eagle Mines (AEM TSX)

• Then: $62.82
• Now: $67.77
• Return: 8%
• Total Return: 9%

Definity Financial (DFY TSX)

• Then: $35.92
• Now: $35.45
• Return: -1%
• Total Return: -1%

Pason Systems (PSI TSX)

• Then: $14.55
• Now: $11.69
• Return: -20%
• Total Return: -18%

Total Return Average: -3%