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(Runtime: 4 min, 53 sec; size: 4.57 MB)
Natalie Taylor, CIBC Asset Management, vice-president and portfolio manager.
There are a number of risks percolating in the market currently such as Brexit, rising tensions in the Middle East, uncertainty with regards to the Fed’s next move. But the single biggest risk investors are focused on currently is the potential escalation of the U.S.-China trade war. Rhetoric has picked up recently, with both sides currently threatening additional tariffs. And we believe this could have major and immediate implications on global growth to the tune of about half a percent to 1%, with additional downside with deterioration of business confidence and pullback from investment associated with that. This is particularly worrisome to me given that we are in the later stages of a recovery, and there’s limited slack in the economy to absorb such a shock.
Unfortunately, the systemic risks that we’re talking about of a meaningful decline in global growth are difficult to avoid entirely and difficult to call with any accuracy because outcomes don’t often follow from logic. So, for example, there’s a scenario in which a deal is reached or that stimulus is introduced to soften the blow of a non-deal, and equity markets just continue to march higher. So instead, I believe the best approach is a portfolio of companies that will participate in the upside, but also provide some downside protection.
So the sectors that are generally thought of as more defensive include utilities, telecom, real estate, healthcare and consumer staples, where earnings tend to be resilient through an economic cycle. On the flip side, resources, industrials, financials, technology and consumer discretionary are more economically sensitive. While earning sensitivity to the cycle is an important consideration, it isn’t the only consideration. The characteristic I’m most focused on in what I view to be a late-cycle environment is leverage. High leverage can be crippling in normal times; it can be devastating in a downturn as financial flexibility is severely impacted.
As a value investor, I’m also focused on low, relative and absolute valuations. And the downside support of hard assets as well, which provide some protection to the downside. Other characteristics such as strong free cash flow generation, attractive business models, strong industry structure are typically characteristics that are essential throughout the cycle. However, [they] add an extra layer of protection in a downturn.
So some of the companies that I’m focused on currently: one would be Westshore Terminals. It’s a terminal operator out on the West Coast, a coal terminal. It’s a scarce asset and the company has no leverage. I think there’s some concerns in the market currently of potential losses of tons through that terminal, but we think that that’s overdone, and we believe that Westshore is in a strong position to maintain the shipment of those tons through its terminal. We think that the valuation is attractive. We think there’s hard assets, providing downside support and, in addition, no leverage on the balance sheet, which provides a lot of flexibility in the event that something unforeseen happens.
Another example is Kinder Morgan Canada. The company has just come through a failed strategic process and there’s been an overreaction in the share price. Again, the valuation is underpinned by strong infrastructure assets, pipelines, storage terminals, and little to no debt to speak of. So we think that gives them optionality for value creation as well.
Other stocks that we’re focused on would be, for example, Loblaws in the consumer staple space. Defensive, given the nature of their business, which is grocery. There tends to be very little fluctuation in the demand for food through an economic cycle. And we believe the company is well positioned in the event that there’s a downturn. Also, some optionality to the upside of all those strategic investments going into click-and-collect and getting groceries to Canadians in a different way. We think the strategic locations of their grocery stores is also a strong asset and should serve them well through a normal economic cycle and on the downside as well.