James Telfser, managing partner and portfolio manager, Aventine Investment Counsel

FOCUS: North American stocks 

MARKET OUTLOOK:

Investment performance in the third quarter of 2023 was characterized by ever-increasing government bond yields. This, in turn, had a ripple effect on risk asset pricing.

The rise in bond yields should not have been that surprising. Perhaps the truly perplexing issue is why they were so low to begin with. In the U.S., the Federal Reserve’s funds rate is at its highest level in decades and guided to stay that way, all while the budget deficit has blown out dramatically. Meanwhile, nominal growth continues at levels in excess of both the central bank’s implicit long-term forecast trend and the average of the post-global financial crisis decade. Bond yields tend to follow strong nominal growth. What is surprising however is the magnitude of the negative impact that slight increases in bond yields are having on the equity market. While higher bond yields result in a reduction of the present values of future cash flows, it does so in a non-linear fashion, much like the impact of interest rates on bond prices.

Should one believe that central banks are at or near their terminal rate, as we do, then it stands to reason that the negative impact of higher rates on equities should have also reached its peak. What remains to be seen is the impact that higher yields will have on economic activity and corporate earnings. We continue to believe that it is prudent to be prepared for at least a mild recession over the coming quarters. We also believe that interest rates will eventually be cut faster than the market anticipates. In the meantime, we continue to position client accounts for volatility. This includes fading expensive stocks in the service sector and using a barbell approach to take advantage of the value in the small-cap universe while offsetting this exposure with a much larger allocation to high-quality and liquid companies.

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TOP PICKS:

Restaurant Brands (QSR TSX)

QSR remains a core holding for Aventine providing exposure to world-class and recession-proof brands such as Burger King, Popeyes and Tim Hortons. The entire management team, including Patrick Doyle as Chairman, and Josh Kobza as CEO, seem to “get it” and should create significant value for all stakeholders, including franchisees, for many years to come. We like the fact that there are multiple levers to pull in order to improve margins, traffic, restaurant growth, and efficiency. These actions should help close the valuation gap with its larger peers. We continue to track progress on cold drink development and afternoon dining at Tim’s, the brand refresh at BK, store efficiencies and the rollout of chicken wings at Popeyes, and new store growth at Firehouse Subs. We believe now is an attractive time to add QSR given the recent pullback in the sector, especially when you consider the resiliency of the business.

Honeywell International (HON NASD)

HON continues to remain a portfolio favourite in the industrial space, balancing a long track record of solid free cash flow generation, attractive dividend yield and strong portfolio positioning for both cyclical and secular trends. The company's operating segments remain attractively positioned over the medium term, focusing on stable sectors such as aerospace, energy and sustainability solutions, and automation. Over the next several quarters, we believe HON will continue to benefit from its investments in leading innovation, particularly in its aerospace division, where industry fleet dynamics look supportive of multi-year growth. Further, we expect the company to capitalize on its historical value creation in non-core lines via divestitures, recycling the proceeds into inorganic growth such as mergers and acquisitions to accelerate the optimization of its portfolio. On balance, the company has multiple strategic tailwinds and levers capable of driving shareholder value regardless of the short-term environment, with further meaningful downside support from its robust backlog.

Trisura Group (TSU TSX)

We believe that the recent share price weakness has created a very attractive entry point for new and existing investors. As a high-growth specialty insurance company in North America, with capital to deploy, TSU has a lot of opportunities to gain market share. Trisura has doubled its gross premiums written from $1.5 billion to $3 billion in only three years and it aspires to double its book value, to $1 billion, by 2027. It has had incredible success in Canada through its corporate and surety insurance programs, and we believe it is looking to expand these offerings in the U.S. as well. TSU recently acquired a regional U.S. treasury-listed surety insurer which we view as an indication that we should expect more growth here. You would have to go back to March-June of 2020 to see the current valuation at 2.3x book value which bodes well for future returns considering the growth profile. While the stock has underperformed after a write-down last year, we believe they handled the situation well, and given the execution over the last couple of quarters, it appears that it is now in the rear-view mirror. 

PAST PICKS: November 24, 2022

Premium Brands (PBH TSX)

• Then: $84.11
• Now: $93.94
• Return: 12%
• Total Return: 15%

Exchange Income (EIF TSX)

• Then: $48.62
• Now: $44.86
• Return: -8%
• Total Return: -3%

Agilent Technologies (A NYSE)

• Then: US$155.35
• Now: US$109.74
• Return: -29%
• Total Return: -29%

Total Return Average: -6%