After several years of positive global economic growth and upwardly mobile stock markets, many investors are fretting about when the good times will end. But Alex Sasso, lead manager of Norrep II, believes there's still some sand left in the hourglass.
"We saw phenomenal growth across the globe in 2017 and early 2018, and we continue to be in an era of positive growth although the pace is decelerating," says Sasso, chief executive officer and portfolio manager at Norrep Capital Management in Toronto. "We are shifting into a late-cycle environment, but contrary to what some people believe, this stage can be good for commodities and equities."
Sasso says the tax cuts introduced earlier this year in the United States added an extra injection of fuel to the cycle, stimulating U.S. stocks and spreading positive sentiment to other world bourses. While there has been some bumpiness in stock prices this year, consumers continue to spend and second quarter earnings reports have generally been strong, Sasso says.
For example, a top holding in the fund, Parkland Fuel Corp. (PKI), more than doubled its revenue and saw a huge increase in profits in the second quarter. Parkland is Canada's largest independent fuel retailer, with 1,850 gas stations under such brands as Esso, Chevron and Pioneer. For the three months ended June 30, net earnings were $60 million, or 45 cents per share, compared to a net loss of $1 million or one cent a share for the same period a year earlier.
Worries about the outcome of trade negotiations and the potential effects of tariffs are casting a shadow over financial markets, but Sasso says that with various deals between the U.S. and its trading partners in flux, it's too soon to measure any impacts.
"There are fears around NAFTA negotiations and a possible slowing of growth in China, but ultimately calmer minds should prevail as investors are able to assess the realities," Sasso says. "Trump will say or tweet something, and it affects certain companies in the short-term, but then stock valuations usually drift back to intrinsic or fundamental levels. It tends to be a gradual recovery, more like a ride on an escalator than an elevator."
Sasso is keeping a close eye on interest rate movements, as he scans the horizon for potential risks. An inverted yield curve, where short-term rates surpass long-term, would be a danger sign and an indicator of looming recession.
"It's important to own the best companies -- those that can grow through various economic conditions and that have a moat to defend against competitors," Sasso says.
Norrep II focuses on small to mid-capitalization companies, a segment of the market that tends to outperform broad market averages over time but can also be more volatile. The average market cap for companies in the fund is currently $2.5 billion.
Sasso maintains a portfolio of 30 to 40 mostly Canadian names, with a mix of growth-oriented and dividend paying stocks, providing "upside potential and downside protection."
The largest sector weightings in the fund at June 30 were basic materials and industrials at close to 25% of fund assets each. These sectors both include businesses that do well in the late stages of the economic cycle, Sasso says. "We are basically overweight in what we call industrial cyclicals, and those companies can span a few different sectors."
He likes base metals, including Trevali Mining (TV), a zinc producer with four operating mines in North America, South America and Africa. Zinc is used primarily for galvanizing stainless steel but is also used in health care products and batteries.
In the base metals area, he also likes Lundin Mining (LUN), a cash-rich diversified Canadian base metals mining company with operations in Chile, the United States, Portugal and Sweden. The company launched a hostile takeover bid in July for fellow Canadian base metals miner Nevsun Resources.
In a related business, another top holding is Major Drilling Group International (MDI ), one of the world's largest drilling and mining industry service companies. Exploration budgets are growing as mining companies expand their drilling programs internationally, Sasso says.
Also among the top holdings is Badger Daylighting (BAD), which has the largest hydrovac excavation fleet in North America. Its trucks use integrated high-pressure water and vacuum systems to expose buried infrastructure or prepare an area for work. Applications include earth removal and trenching, and clients include energy and utility companies.
Sasso says to be eligible for the fund, companies must meet the firm's stringent quantitative and fundamental criteria, but most importantly, must have a strong and capable management team.
"With real estate, the three most important things are location, location, location and with small caps they're management, management and management," Sasso says. "With smaller companies, the management team has a huge impact. Layered on top of that are things like cash flow and the balance sheet."
He likes to hold favoured companies for a long time but will trade around positions as they move up and own in price, taking profits when they become more expensive and adding to positions when prices are down.
Recently, the fund added to its holdings in transportation company TFI International (TFII). The company is involved in trucking services as well as package delivery and courier. Sasso says it is trading at a reasonable valuation and is showing a pickup in revenue and profit growth.
Diversification is also important to Sasso in lowering risk and levelling out volatility. For example, the Norrep II fund's holding in Sleep Country Canada Holdings (ZZZ) represents a completely different business than mining. The mattress retailer has been a consolidator in the industry and is benefitting from the closure of department store Sears Canada.
