The U.S. economy have made a turn for the better in recent weeks, but there remain plenty of signs that warrant near-term caution for equity investors.
Although housing, autos, wages and other job-related data appear to be improving, important indicators such as market breadth happen to be fairly weak for the S&P 500 and S&P/TSX composite indexes.
Trading volumes are rather tepid and monitored sentiment data indicate high levels of investor complacency. Recent data in the American Association of person Investors reveal that the bulls and bears are about even, but a lot of institutions are sitting in neutral.
“We’ve had a really choppy market in which the indexes have effectively done nothing for around eight months,” said Mike Archibald, a portfolio manager at Aurion Capital Management, pointing towards the uncertainty surrounding the U.S. Federal Reserve’s next moves in addition to relatively weak Canadian and U.S. earnings.
But since stocks look fairly valued for the most part, the Aurion team, including co-managers Greg Taylor, Craig MacAdam and Bob Decker, thinks raising some money makes a large amount of sense at this time.
The managers from the?Dynamic Aurion Tactical Balanced Fund and the Aurion II Equity Fund aren’t with a market correction, but using a bit of dry powder to purchase good businesses is going to be useful if stocks withdraw three to seven percent – something they think about a real possibility.
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They also recommend being fairly selective in terms of both sector and stock selection, favouring Canadian names in the non-bank financial and non-retail consumer discretionary sectors, as well as health-care stocks on sides from the border.
“They still exhibit very strong momentum characteristics in terms of fundamental earnings growth, cash-flow growth, sales growth, while valuations by and large aren’t that expensive,” Archibald said. “They also have good economic sensitivity awaiting global growth into 2016 and 2017.”
Taylor noted that M&A trends are required to remain, so names such as Valeant Pharmaceuticals International Inc. (VRX/TSX) and Concordia Healthcare Corp. (CXR/TSX) should still add value.
“We’re still in this unique environment where the acquirer is going up as much as the acquiree in some instances,” he said. “It\’s really a function of the low interest rate environment, but we think Fed hikes won’t be sufficient to kill that theme.”
Valeant is adding organic growth to the growth-through-acquisition story, but the company certainly has the balance sheet and firepower to create more deals.
Meanwhile, Concordia is like the next Valeant: a younger company having a beneficial tax position following the same acquisitive strategy.
The M&A theme also permeates non-bank financials. Archibald highlights Element Financial Corp. (EFN/TSX), that has raised $2.6 billion within the expectation of creating a large acquisition, either General Electric Co.’s vehicle-fleet-management business or something similar.
“We really like this business as it’s got a lot of torque,” he explained. “It’s pretty cheap, and if they are able to do this in a reasonable price, there\’s material upside to earnings and profitability going forward.”
Recent addition Cott Corp. (BCB/TSX) also fits into the acquisition theme, as well as the managers’ preference for non-retail consumer stocks that also happen to generate a lot of revenue outside of Canada.
Once a soft drink maker beholden to pricing pressure from Wal-Mart Stores Inc., Cott’s purchase of a home-and-office water delivery company quickly made it the second-largest U.S. player for the reason that business.
“They\’re executing very well, and they are deleveraging quickly because it’s a big cash-flow business,” MacAdam said. “There are a good deal of possibilities to improve the business, in addition to make tuck-in acquisitions.”
Seeing some weakness in pure retailers, evidenced through the recent struggles of Wal-Mart and Target Corp., the managers have sought contact with the consumer in areas for example gaming through names like Intertain Group Ltd. (IT/TSE) and NYX Gaming Group Ltd. (NYX/TSX-V).
“Frankly, the valuations got a little too rich for us in the retail space,” Taylor said. “They\’re still good companies, but with concerns about Canadian personal debt levels and if the west is going to have a recession because of the oil selloff, is it really the time for you to stretch on valuations? For all of us, it’s just time to step back from that space to check out growth in other locations.”