While equity market sentiment continues to be bleak, Lutz Zeitler argues that the evidence for a significant economic slowdown is lacking. As a consequence, Zeitler is continuing to invest in a select group of companies that he believes have solid long-term fundamentals.
“A lot of the time we see concerns that drive market sentiment, either positive or negative. Right now it’s negative, and it is based on ‘concerns,’” says Zeitler, managing director and head of Canadian fundamental equities at Toronto-based BMO Asset Management Inc. “There are concerns about trade wars, Brexit, and general economic growth. But the evidence for a severe economic slowdown is not there. We are still seeing positive leading economic indicators.”
One bellwether is the ISM, or Institute for Supply Management, which monitors views of purchasing managers and had a reading of 59.3 points on December 1, a small drop from 60.3 a month earlier. Expectations were for 57.5 points. “My point is that market sentiment is so weak and expectations are so low by market participants,” says Zeitler, noting that volatility has shot up to levels last seen in February 2018 when inflation fears sent markets into a tizzy. “But housing data in Canada and employment growth remain strong. There is no evidence that we are in for a severe slowdown.”
Zeitler, who is lead manager of the $5 billion BMO Dividend A, argues that rather than dwell on day-to-day issues and concerns, it’s wiser to simply focus on bottom-up stock-picking. “We ignore the noise in the market because most of the time, it’s just that, noise. We look for companies that we believe are positioned for long-term secular growth. We try not to worry about some of these macro indicators which drive market volatility.
“If we invest in good, solid companies that have secular tail winds, that are positioned well in their industries, have the right management teams and strategies, and have ‘moats’ around their business, that will drive better investor value creation over the long-term,” says Zeitler, a 23-year industry veteran who has an MBA from the Richard Ivey School of Business and joined BMO in 2000.
Typically, Zeitler notes, market sentiment can change very quickly, when it digests a catalyst of some sort, such as some economic data. That can change sentiment for the better, or the worse. “Then investors start to look at what really matters: earnings growth,” says Zeitler, who shares duties Philip Harrington, portfolio manager. “In January and February a lot of companies will report their fourth quarter numbers, with management commentary. That will be the catalyst to either support this negative sentiment or contradict it and get us back to stability and growth. I believe there will be solid earnings reports.”
Fully invested, Zeitler has allocated about 77% of the portfolio to 32 Canadian stocks and 21% to 11 companies based in the U.S. The latter portfolio weighting is driven by the broader stock selection south of the border where there are consumer discretionary, information technology and health-care companies not available at home.
In terms of criteria, Zeitler says that first and foremost he looks for firms that can raise their dividend in a sustainable manner. “All the other criteria fall out of that one,” says Zeitler. “A company needs to have certain attributes to be in a position to sustainably grow the dividend in the future. That includes a strategy that makes sense, a strong management team that can pursue that strategy and a balance sheet that can finance that strategy. Pricing power and predictability of their cash flow are also very important. All these pieces fit together to ascertain whether that company can sustainably grow dividend. That’s our philosophy.”
One representative holding is Brookfield Infrastructure Partners LP Units (BIP.UN), a firm that is a member of the Brookfield Asset Management Inc. (BAM) family of companies. The firm invests in large-scale projects such toll-roads, pipelines and communication towers. “There is a huge need for large-scale infrastructure globally, so Brookfield is in the right area. There are not many players who can bid on these projects. With the backing of BAM, they have the support to bid on these projects. That’s their competitive edge.”
Zeitler notes that many sovereign wealth funds are under-invested in infrastructure assets and are keen to increase their participation. “When you think of that pool of assets, globally, there is huge demand to invest in these types of projects. They do that through BAM, which raises third-party assets, which comes from sovereign wealth funds,” says Zeitler, adding that BAM invests alongside Brookfield Infrastructure in many projects. “This area has huge secular tail winds. We see long-term growth for that name.”
The shares pay a 5.1% dividend, which Zeitler says has been growing at about 15% a year. His expectation for the stock is that it could appreciate about 20% in the next 12 to 18 months.
Within the U.S. market, Zeitler likes TJX Companies Inc. (TJX), an off-price retailer that has brands such as Winners. The firm dominates the category and has about 4,200 stores globally, but mostly in North America. “They could see growth in stores by about 50% in the next 10 years. And they will achieve it through internal cash flow generation.”
Although the retailing sector has been hurt by the online alternative, Zeitler believes that TJX can prosper because it has a competitive edge in the form of its massive buying power. “They have over 1,000 buyers who source from over 17,000 vendors in over 100 countries. That is very difficult to replicate,” says Zeitler. “Because their merchandise is so unique it changes the consumer’s mindset into a ‘Let’s see what they have on sale this week’ experience. A lot of repeat customers go their stores to find the treasured piece they weren’t even sure they were looking for.”
Although the stock pays a meager 1.7% dividend, Zeitler notes that the firm is reinvesting most of its profits back in the business, which should see its earnings grow about 25%. Total return expectation for the stock over 12-18 months is 15%.
The last 12 months have been challenging for Canadian equity markets which have lost over 12%. In contrast, the 3-star rated fund lost 10.9% in value and generates a running yield of 3%, before fees.
Yet Zeitler is upbeat. “Although the data suggests we may slow from the rapid pace of 2018 I don’t see a recession on the horizon and believe we will still be in a healthy equity environment for 2019. Markets go through downturns every year and it doesn’t feel good when it happens. But more times than not, the market rebounds and gets back to the fundamentals and is supported by real data.”
