Stock Picks to Watch Amid a Soft Landing

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Natalie Taylor, portfolio manager at CIBC Asset Management. 

Global economic forecasts have largely been revised upwards over the last few months as economists have come around to the idea that a soft landing is possible. 

So, tighter financial conditions from rate hikes, as well as normalization of supply chain, has really helped reduce inflation from a peak of about 9.1% in June 2022, to the most recent reading of 3.1% in January of 2024. 

But inflation still remains above central banks’ long-term target of 2%, a level where rate cuts would be justified. So as a reminder, the market strength we saw late in 2023 priced in rate cuts beginning as early as March 2024, due to the progress that we’ve made on inflation. However, we’re at an interesting crossroads right now, where the economy continues to do well and, in many areas, re-accelerate. Employment continues to be strong. Consumer confidence and retail sales, particularly in the U.S., have held up much better than anyone has expected. 

So, there is a risk that the strength in the economy halts the decline in inflation and eliminates the need for rate cuts in 2024 or pushes them back. In this scenario, equities could perform poorly, particularly high valuation stocks, such as technology, as well as interest-sensitive and highly leveraged companies that have been pricing in rate cuts this year. So, to navigate a soft landing, we need a Goldilocks scenario, where growth is solid but not too strong, to continue the drive in global equities higher and to keep the dream of lower rates in 2024 alive. 

Aside from the outlook for growth and interest rates, there are a number of factors that could impact the performance of equities this year. So, firstly, in 2024, I think nearly 60% of global democracies are holding elections. And that includes half the world’s population. And the biggest one being at the end of this year in the U.S. This is a rematch between Biden and Trump, potentially. And we can look to 2016, when Trump was first elected, to see what some of the changes could be. So, a change in administration could result in additional tariffs, lower corporate taxes, a potential delay in the energy transition, more M&A, and a pullback in other government spending, potentially on infrastructure as well. Other big elections include Mexico and the U.K., so something to watch there. 

I think, second, is a continuation of the mounting geopolitical risks that we’ve seen. So, an escalation of conflict in Eastern Europe, in the Middle East, a potential conflict in Asia. All these can have a meaningful impact on global commodity prices and supply chains as well. 

Third, we’re also closely monitoring the knock-on effects from tighter financial conditions, particularly on real estate. So, since the financial turmoil in March of ’23, regional banks have pulled back on commercial real estate lending. And there’s been a lack of transactions in the real estate space and very poor visibility on prices. 

So, we think that, in 2024, frequency of these transactions could pick up. And we could see some losses crystallized, and potential impact, or ripple effect, through the economy, the degree of which is unclear. But, ultimately, I think this price certainty needs to be realized in order to remove some of the uncertainty in the market. 

I think the last point to make is on AI, which has been a big driver of strength in the market, driving the Magnificent Seven up quite meaningfully in 2023. And this continues into early ’24. So, I think, currently, the demand for GPUs [graphics processing units] is exceptionally strong and continues to grow. But there is a risk that, at some point, there’ll be some capacity limitations that could restrict growth. Important to watch that, going forward. Recent indications are that we’re not there yet, but as mentioned, something to pay attention to. 

And, of course, there’s always the risk of the unknown, which markets tend to react to much more severely than some of these risks that we have visibility on. 

The current market is very dynamic, but rife with opportunities from a stock seeking perspective across many different sectors. So Covid’s disruption on the economy was uneven, supercharging demand on consumer goods and technology solutions, while all but eliminating demand for travel and services. As such, the cycles for goods and services have decoupled. And perhaps this lack of alignment is the reason we’ve yet to experience the recession experts have expected. 

But bringing it back to stock picking, we see good opportunities. And one area to highlight is in transport stocks, which are tied to the consumer goods economy. And I’d highlight the rails as well as the less-than-truckload companies, which are poised to grow volumes again after a freight recession experienced in 2023. So, the rails, I think this is a fairly well-known story, have high barriers to entry, much lower cost to serve than trucks, allowing for better pricing dynamics through the cycle. We like CP, which has proven to be a very strong operator and has added to its network recently through the acquisition of Kansas City Southern. And extending its reach into Mexico, which we believe is a strategic advantage. 

TFI International is also a top pick. It’s half specialty truckload, which is fairly profitable, and half less-than-truckload, or LTL, business. And LTL is a unique business within transport that has high barriers to entry in the form of terminals and real estate, so more capital intensive. And has recently experienced pretty meaningful industry consolidation, leading to better competitive dynamics. We believe there is an opportunity for TFI to leverage its operational know-how, and to continue to improve its operating ratio in LTL over time. And this is a playbook that’s worked well for surfacing value with the rails over the last few decades. 

Within financials, we see an interesting opportunity in Manulife. So, for Manulife and other life insurance companies, higher interest rates have helped increase demand for its products, and increased returns on its investment portfolio as well. However, the stock has continued to trade at a discount to peers, due to continued concerns related to its long-term care book of business. Recently, Manulife entered into a transaction to reduce its exposure to LTC at favourable terms. And this is a trend we expect to continue. Ultimately, these actions will release capital and improve profitability, which should result in a re-rating in the stock over time. 

Lastly, within industrials, we like WSP, an engineering and design firm, that has a strong outlook for growth. Growth, recently, has been supercharged, driven by infrastructure investment and energy transition projects, which we expect to continue for some time. WSP’s scale and expertise positions it well to win more than its fair share of high-profile projects which, in turn, attracts engineers and drives profitability. The firm also has a long runway for inorganic growth in a highly fragmented industry, and the deals it’s done in the past have been highly accretive to its growth.