AS EARNINGS SLOW, DENNIS MITCHELL HAS HIS EYE ON BUYING OPPORTUNITIES.
At the start of 2017, politics dominated investors’ minds. Elections in major core euro zone nations including the Netherlands, France and Germany posed a large amount of risk, as anti-European sentiment was gaining traction. Across the pond, things were very different, as Republicans took control of both the White House and Congress after years of divided governments.
But as the year rolled on, the political risk in Europe declined as elections played out favourably for markets, while problems in the U.S. heated up with President Donald Trump’s administration setting a new bar for dysfunction in Washington.
The Senate’s recent rejection of a proposal to repeal and replace Obamacare makes it very unlikely that Trump will be able to achieve any sort of tax reform in 2017. Yet U.S. equity markets continue to reach record highs.
“To the extent that markets were expecting another fiscal boost from the Republicans delivering on tax cuts, that will be a disappointment, and you might see some weakness in the market,” said Dennis Mitchell, senior portfolio manager at Sprott Asset Management.
He runs th eS prott Focused Global Dividend Class, a go- anywhere portfolio that targets companies with strong returns on invested capital, strong recurring cash flow, irreplaceable assets, and little debt.
“From our standpoint, we’re at a bit of an inflection point that might resolve itself very shortly,” Mitchell added, noting the optics of U. S. earnings- per- share growth normalizing is another thing to be concerned about.
While EPS have recovered nicely from the recession (year-over-year declines) experienced at this time last year, those quarters are now being lapped. Mitchell highlighted the fact that EPS growth for S&P 500 companies was nearly 15 per cent in the first quarter. That compared to a long-term average since 1980 of about six per cent.
“When you’re doing 2.5 times the long-term average, you know that is not sustainable,” Mitchell said. “We don’t think EPS will turn negative, but the perception that EPS growth is moderating or falling — and companies are less-profitable — gets investors anxious.”
The portfolio manager believes that could create a buying opportunity in the near future, keeping in mind that the potential for meaningful fiscal stimulus hasn’t disappeared, but is instead delayed. He noted that Sprott has double- digit cash weightings in several portfolios in anticipation of such a pullback.
“Companies have t he ability to grow their EPS, and some can still be found at discounted multiples,” Mitchell said. “So longer term, we’re not overly concerned about markets as a whole.”
The Sprott Focused Global Dividend Class has benefited from Mitchell’s shift in favour of European equities (over U. S. stocks) earlier in 2017. However, since U. S. equities have done so well, the fund’s allocation to the U. S. hasn’t declined all that much.
One example of a fund holding that just keeps goi ng up, even as Mitchell trimmed his core position (while selling other U. S. financials completely), is JPMorgan Chase & Co. (JPM/NYSE).
“It has a fortress balance sheet, a solid loan book, a global footprint, and a very strong franchise, along with tailwinds on the back of anticipated fiscal stimulus,” he said. “We exited some of the other positions because we think the thesis played out, and now our return risk is skewed in an unfavourable way. They went from being relatively cheap to fairly valued in a short period of time.” Cineworld Group PLC ( CINE/ LON) has been another strong performer in the portfolio this year. The company owns and operates the largest chain of movie theatres across the U.K., and has a meaningful footprint in Eastern Europe.
Mitchell noted that Cineworld has benefited from a strong film slate this year, but it is also going to benefit from next year’s offerings, which should be even stronger with the next movie in the Star Wars franchise and a couple of Marvel movies.
The company recently completed an acquisition that will provide more scale in Eastern Europe, where it will apply its own internal standards that will drive some economies of scale.
“The natural momentum of attendance being driven by the film slate leads to higher ticket prices, and then higher food and beverage spend,” Mitchell said. “If there isn’t a similar increase in the operating costs of a business, then that leads to margin expansion and cash flow growth.”
The portfolio manager also highlighted the fund’s position in Google parent
Alphabet Inc. ( GOOG/ Nasdaq), whose primary business revolves around search and is therefore really simple to understand.
Mitchell noted that outside of China, Google has roughly 65- per- cent market share, and a business model that has been tested.
“Microsoft had the competitive advantage of being able to roll Bing — their competing product with Google — into Windows and Microsoft office,” he said. “They almost had unlimited capital, and still weren’t able to put a meaningful dent into Google’s business and market share.”
“This is one of those dominant global franchises that seems to get better and better every year,” Mitchell added.
While popular tech stocks like Facebook Inc., Amazon. com Inc. and Netflix Inc. have come under some pressure lately because they’ve worked so well, he believes this provides an opportunity to build the fund’s position in Alphabet.