Heading into 2019, the equity research team at Desjardins Securities recommends investors “remain steadfast in looking for the best-positioned names” in order to battle through the current market volatility.
“2018 began with so much promise, marked by an improving economic picture, Trump tax cuts and rising corporate profits,” said the firm. “But the wheels began to fall off, with growing protectionism, rising raw materials costs and looming rate hikes beginning to eat into corporate profits amid an overheating US economy, with the consumer not far behind given rising household debt, especially in Canada. The global markets are well into negative territory for the year, with most of the damage occurring in 4Q. Further, most industry prognosticators are now calling for a recession, either in late 2019 or in 2020, with challenges remaining (eg outcome of China–U.S. trade spat, rising rates, stretched balance sheets).”
In a research report released Tuesday, the analysts revealed their top 28 stock picks for the coming calendar year spread across eight sectors. Their selections for 2018 provided an equal-weighted average total return of negative 2.2 per cent, exceeding both the negative 12.6-per-cent performance for its entire coverage universe and the 6.2-per-cent dip for the S&P/TSX index.
“While the gifts may not be overflowing this season, we believe there remain many opportunities to pick from at Boxing Day sales, with our analysts highlighting the best bargains —generally the most recession-resistant names under coverage, with resilient top lines regardless of cycle, stable margins, solid balance sheets and growing cash flows,” they said.
Here’s a brief summary of their outlook on a sector-specific basis:
Consumer Staples/Consumer Discretionary
Analyst Keith Howlett: “The S&P/TSX Capped Consumer Discretionary Index is posting a miserable performance in 2018, with a year-to-date total return of negative 14.7 per cent, faring better than only energy stocks. 14 of the 18 constituents posted negative returns. Earnings growth of companies such as Dollarama and Canadian Tire fell slightly short of expectations, while fears of a future economic slowdown mounted. The shares were severely punished. As investors flee discretionary stocks, consumer staples are posting a 4Q rebound quarter-to-date, led by grocers. Staples stocks posted a total return of 3.7 per cent year-to-date. Looking ahead, our view is that the U.S. Federal Reserve’s rate decisions and balance sheet reduction initiatives will set the tone for the stock markets in 2019. The shift to the digital economy will continue to dominate the dialogue around retailers and, to a lesser extent, brand owners. We favour the best managed companies, with reasonable valuations, and relatively less exposure to the immediate threat of digital disruption.”
Diversified Industrials
Analyst David Newman: “As we enter 2019 amid the current market volatility, we continue to favour companies with strong, defensible business models as highlighted by their leading market positions, recession-resistant cash flows, reasonable debt loads and visible growth opportunities. While they are not immune to some of the current headwinds (eg rising labour, freight and debt service costs, slowing economy), we believe our top picks are well-equipped to manage through the challenges. Given we are late in the cycle with modest rate increases expected, we anticipate there could be an acceleration in M&A as companies seek to diversify their businesses, build scale and increase their exposure to higher-growth markets, driving subsequent organic growth.”
Financial Services
Analysts Doug Young, Gary Ho and Aditya Gupta: “For the Canadian banks, the focus in FY19 will be acutely on credit and whether we finally see credit trends start to turn, given we are arguably in the late stages of the credit cycle and household debt levels are elevated. Otherwise, NIM [net interest margin] expansion should continue (partially offset by deposit betas and increased competition in the commercial segment), and we believe the banks will further reduce expense ratios in order to offset slowing loan growth. For the lifecos, a sustained increase in 10/30-year bond yields would be favourable, and we see a few catalysts that should drive core EPS growth; however, sentiment could be negatively impacted if equity market volatility remains elevated. For the asset managers, we expect industry net flows to be flat to slightly higher in 2018, ETFs to continue their momentum and investors to pay greater attention to both alternative assets and expense management.”
Industrials/Transportation & Aerospace
Analyst Benoit Poirier: “2018 started on a strong note, with investors contemplating the positive impact of U.S. tax cuts implemented at the end of 2017. Supported by solid economic conditions, industrials stocks performed well in 1H18. However, fear of rising interest rates and a trade war have resulted in market uncertainties. In this report, we take a closer look at the fundamentals behind each sector. Our view is that the recent stock correction is overdone and we maintain our overall bullish stance heading into 2019.”
Oil & Gas
Analysts Justin Bouchard, Kristopher Zack and Chris MacCulloch: “Although we are cautious on the potential for significant unintended consequences stemming from Alberta production curtailments in 2019, we believe that the sharp collapse in investor sentiment has created some attractive entry points within the Canadian oil & gas sector and see better near-term support emerging for oil prices. That said, we remain biased toward producers that could benefit from the curtailments while also considering sustainability, financial flexibility and relative valuation.”
Power & Utilities
Analyst Bill Cabel: “2018 was a tough year for a majority of our IPP [independent power producer] coverage—a bit of a ‘death by a thousand cuts’ as a combination of rate hikes, political changes, below-LTA generation and quarterly misses led to periods of significant negative pressure on share prices and an overall challenging year for the sector. Going forward, bad macro news is expected to mean good news for our stocks, and we appear to be exiting 2018 with heightened fears around a possible approaching recession or bear market, which would likely soften further rate hikes and could lead to our coverage names outperforming the broader S&P/TSX index. Further, we believe the world is transitioning to decarbonization and electrification, which our names are well-positioned to take advantage of. We continue to believe that in order to generate outsized returns, our IPPs will need to continue to move into new jurisdictions and technologies—as they have done historically.”
Precious Metals
Analyst Josh Wolfson: “We continue to believe global rates have begun a period of normalization and that the cessation of extraordinary financial stimulus represents a longer-term headwind for gold. However, we do not expect rates to rise immediately and in a straight line, and we acknowledge a more constructive short-term view given heightened macro uncertainties.”
Real Estate
Analysts Michael Markidis and Kyle Stanley: “With a mere two weeks to go, it seems highly likely that 2018 will go down as a year in which the S&P/TSX Capped REIT Index (year-to-date total return of 10 per cent) significantly outperformed the broader Canadian market. We remain bullish on the operating environment in the multifamily space; however, we are cognizant of the superior run (and multiple expansion) that certain names have enjoyed throughout this year.”
Telecom, Media & Tech
Analyst Maher Yaghi: “We believe underlying trends, supported by a resilient wireless market, should continue to help the sector. However, unlike in previous years, ABPU [average billings per user] growth is likely to be muted in 2019.”
David Leeder