Port­fo­lio man­ager fore­casts earn­ings growth and rate hikes with re­fla­tion trade, writes Jonathan Rat­ner.

Edmonton Journal - - FINANCIAL POST - Fi­nan­cial Post jrat­ner@na­tion­al­

The so-called Trump trade that pro­vided a big lift to value and cycli­cally ori­ented eq­ui­ties has lost some steam, as sev­eral of the U.S. pres­i­dent’s prom­ises on tax re­form, reg­u­la­tion and health care haven’t come through.

Many of the stocks that ben­e­fited from Don­ald Trump’s elec­tion win in Novem­ber — cheaper ar­eas of the mar­ket such as con­sumer dis­cre­tionary, fi­nan­cials and industrials — have pulled back. Mean­while, bonds, util­i­ties and other de­fen­sive plays have be­gun to rally again.

“We’re at a point where the mar­ket is re­ally start­ing to worry that we are go­ing to sink back into de­fla­tion,” said Ja­son Mann, chief in­vest­ment officer at Edge­hill Part­ners.

Mann, who runs the firm’s EHP Ad­van­tage Fund, a di­ver­si­fied North Amer­i­can long-short equity fund, thinks it’s too early to call an end to the re­fla­tion trade. He con­tin­ues to an­tic­i­pate earn­ings growth and ris­ing in­ter­est rates, and is favour­ing cycli­cal stocks over de­fen­sives as a re­sult.

“We think it’s a pause, not an end,” he said, em­pha­siz­ing his fo­cus on qual­ity value stocks.

“Last year, it was all about buy­ing stocks that didn’t go broke, as re­ally cheap price-to-book and over-lev­ered com­pa­nies did the best. This year, we think you want to fo­cus on higher-qual­ity, cheap price-to-free cash flow, rea­son­able bal­ance sheet, and high re­turn-on-equity com­pa­nies.”

The port­fo­lio man­ager is stay­ing away from growth stocks, de­spite in­vestors’ per­sis­tent love for ex­pen­sive ones such as Tesla Inc. “By all mea­sures, Tesla is ex­tremely over­val­ued, but it just keeps grind­ing higher,” Mann said. “But, ul­ti­mately, in­vestors tend to ro­tate back into qual­ity and cheap stocks, and avoid su­per-ex­pen­sive growth names, es­pe­cially as you get late into the cy­cle, which is where we think we are.”

Mann be­lieves now is a good time to re-visit some of the names that sharply moved up in Novem­ber, but have since set­tled back. He also sees an op­por­tu­nity to re-po­si­tion away from bond­like stocks such as util­i­ties, tel­cos and REITs to some de­gree, since they’ve all recovered some­what from the Novem­ber sell-off.

“Frankly, they are still quite over­val­ued re­lated to the cycli­cal parts of the mar­ket,” he said.

The type of value Mann is tar­get­ing can be found in the con­sumer dis­cre­tionary, fi­nan­cial, in­dus­trial and even tech­nol­ogy sec­tors.

The tech names cer­tainly do not in­clude the likes of Face­book Inc., Ama­ Inc. or Net­flix Inc., but com­pa­nies such as Ap­ple Inc., Texas In­stru­ments Inc., KLA-Ten­cor Corp. — older parts of the sec­tor — are cheap, and that’s an ex­am­ple of where Mann prefers to be po­si­tioned on the long side.

He also high­lighted sev­eral Cana­dian names, one of which is ECN Cap­i­tal Corp. A spinoff last fall from El­e­ment Fi­nan­cial Corp., ECN was in­tended to be El­e­ment’s growth ve­hi­cle in the leas­ing fi­nance busi­ness.

“It’s kind of been an or­phan stock since the spinout,” Mann said, not­ing that ECN trades at a roughly 25-per-cent dis­count to book value, while leas­ing busi­nesses tend to trade closer to book value.

“It’s a pretty mean­ing­ful dis­count and they have a ton of ca­pac­ity to do ac­qui­si­tions,” the man­ager added, not­ing that ECN has ap­prox­i­mately $3 bil­lion of bal­ance sheet ca­pac­ity to buy other leas­ing busi­nesses.

If ECN can’t find cheap busi­nesses to ac­quire, Mann pointed out it can still lever up by re­pur­chas­ing stock. “These busi­nesses work bet­ter when they have more lever­age than what ECN cur­rently has,” the man­ager said. One of the more cycli­cal parts of the mar­ket that’s shown some re­cent strength is the Cana­dian forestry and lum­ber sec­tor.

Many of the sec­tor’s names are in pretty good shape with Mann point­ing to both West Fraser Tim­ber Co. Ltd. and Can­for Corp. But he also high­lighted In­ter­for Corp. given that just 15 per cent of its vol­umes are sub­ject to tariffs. “The big fear has been that the tariffs the U.S. has put on soft­wood lum­ber would re­ally hurt these com­pa­nies,” he said.

But tariffs tend to raise prices ev­ery­where, since they es­sen­tially act as a tax. As a re­sult, In­ter­for’s U.S. pro­duc­tion (twothirds of its lum­ber ca­pac­ity is in the U.S.) will be sold at a higher price. “Ul­ti­mately, tariffs are not a sig­nif­i­cant head­wind for this com­pany,” Mann said. “If any­thing, it’s a ben­e­fit.”

Another in­dus­try in­vestors may feel is vul­ner­a­ble to pro­tec­tion­ist U.S. trade poli­cies is Cana­dian auto parts. If NAFTA is torn up, there is a risk to com­pa­nies such as Magna In­ter­na­tional Inc., Li­na­mar Corp. and Mart­in­rea In­ter­na­tional Inc. But even with a “Buy Amer­ica” pol­icy in place, auto man­u­fac­tur­ers can’t just make the switch overnight.

“Ul­ti­mately, the best prod­uct at the right price wins, and Cana­dian auto parts have in­te­grated them­selves well into the man­u­fac­tur­ing cy­cle,” Mann said.

He sin­gled out Mart­in­rea as be­ing at­trac­tive given its very cheap val­u­a­tion and some­what stretched bal­ance sheet, which means the com­pany has more torque to any im­proved busi­ness.

“It’s kind of been in turn­around mode for a while, but now their mar­gins are start­ing to im­prove, and there is a real op­por­tu­nity to im­prove cash flow from their cur­rent as­set base.”

We’re at a point where the mar­ket is re­ally start­ing to worry that we are go­ing to sink back into de­fla­tion.


Ja­son Mann of Edge­hill Part­ners be­lieves now is a good time to re­visit some of the names that sharply moved up in Novem­ber, but have since set­tled back.

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