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bnn market call

Paul Harris

Paul Harris is partner and portfolio manager at Avenue Investment Management. His focus is North American and global equities.

Top Picks:

Kraft Heinz (KHC-Q)

Kraft Heinz provides food services and food products including ketchup, Kraft Dinner, etc. The stock has a 3-per-cent dividend yield and trades at 20 times 2017 earnings. It continues to see cost cutting and organic growth through better distribution of Kraft products through the Heinz distribution network.

Apple (AAPL-Q)

Apple is a manufacturing and service company of computers and mobile devices. The stock trades at 10.6 times earnings, and trades at 10 times earnings with a 2.4-per-cent dividend yield. Although the next several quarters maybe difficult due to poor iPhone sales, we think we will see better earnings as new products are launched in the next quarter.

Nike (NKE-N)

Nike is engaged in the design, development, marketing and selling of athletic footwear, apparel and equipment. It has a great global brand, which continues to grow its online presence and its emerging markets revenue. The stock has underperformed of late, and we see this as a good opportunity to purchase the stock, as it trades at 25 times earnings and has a 1.16-per-cent dividend yield.

Previous picks: Oct. 1, 2015

FirstService (FSV-T)

Then: $33.27 Now: $46.43 +39.56% Total return: +40.69%

Element Financial (EFN-T)

Then: $17.90 Now: $14.99 -16.26% Total return: -15.82%

DH Corp (DH-T)

Then: $39.74 Now: $29.25 -26.40% Total return: -23.42%

Total Return Average: 0.48%

Market outlook:

Despite the bouts of volatility we have seen, I think stocks are going to continue to re-rate higher. With interest rates continuing to march lower across the world, there is still more relative compensation for being in the stock market than being in the bond market (unless you need fixed income as part of your asset allocation.)

The forward earnings yield on the S&P 500 and TSX are still over 5.5 per cent, while bond yields are at 1.25 per cent in Canada and 1.67 per cent in the U.S. I think stocks will re-rate higher as the price people are willing to pay for corporate cash flows will continue to increase because of paltry bond yields and volatility being suppressed by central banks.

I think this re-rating of the stock market could happen much sooner, if we see any positive earnings momentum in 2017. Earnings have basically been flat for the S&P since 2014, while the TSX earnings were down in 2016 versus 2015. Some estimates I've seen for the TSX have aggregate earnings around 910 to 915 for 2017. For simplicity, if we use an earnings number of 900 and give it a multiple of 18x (based on relative value to low bond rates), we get an index value of 16,200 pretty quickly. Albeit this is largely dependent on energy earnings, which could disappoint again next year if we do not see a recovery in the price of oil. If we do see a recovery in earnings, I think people are underestimating how quickly the stock market can re-rate higher.

Looking at the S&P 500 quickly: Aggregate earnings have been around $118 for 2014, 2015, and 2016 on the back end of weak energy and financials earnings. Estimates for next year are somewhere around $125-$130. This estimate may be too optimistic, but if we use a multiple of 18x on $125 we arrive at 2,250 on the S&P 500 very quickly as well.

These are the dynamics going on in the stock market, which are contingent on central banks continuing to be stimulative, economic growth remaining low, and very limited inflation. All of which will keep bond rates low and make the stock market continue to look attractive in relative terms.

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