‘Laissez les bon temps rouler.’ And the Cajun French certainly know how to do that. It’s that ability to spend and celebrate, no matter what hardships or geopolitical tensions exist, that leads The MoneyLetter columnist John Stephenson to three consumer stocks that will continue to profit from: ‘Let the good times roll.’
While markets may be a sea of calm, geopolitics are anything but. Yes, the stock markets in North America are eking out new highs; nevertheless, plenty of problems are keeping investors up at night. Chief among them are an unraveling of NAFTA, conflict with North Korea, and deteriorating US-China relations.
Will NAFTA unravel?
The fourth round of the North American Free Trade Agreement (NAFTA) renegotiation ended recently, with Mexico and Canada rejecting what they view as harsh US proposals. Some reports have suggested that there has been a little progress on the less contentious parts of the agreement.
Investors are right to be cautious about the risks of NAFTA unraveling, given the tough positions laid down by US negotiators and the threatening rhetoric from US President Donald Trump. Market risks are biased to the downside, given that a good outcome is priced in, in both Canadian and Mexican markets.
How stable is the Korean peninsula?
The big risk with North Korea, at least from a markets perspective, is the threat to regional stability, US security and nuclear non-proliferation. There is little doubt that the risk of an armed conflict has risen, given North Korea’s missile launches over Japan, a nuclear test and an intense war of words. This has without doubt raised the chance of a misstep or miscalculation.
But despite the temperature in the room, there’s likely a low probability of an all-out war; the costs are too high on all sides. Instead, I expect the US to intensify its ‘peaceful pressure’ campaign, evident in imposing unilateral sanctions and leaning hard on China to participate. The North Korea crisis will likely strain US-China relations just as economic tensions are rising.
US-China tensions rising
The friction between the US and China will heat up over time. Trade and market access disputes will only exacerbate an increasingly competitive US-China relationship in the long run. I believe that markets have yet to factor in this gradual deterioration.
In the short term, tensions could rise if Chinese President Xi Jinping pursues an even more nationalistic agenda in the wake of the National People’s Congress. Economic tit-for-tats could lead to an erosion of relations—and have sector specific effects.
While the possibility exists that US military action against North Korea and/or an accidental clash in the South China Sea would deal a blow to the relationship, this remains an outside possibility. The more likely case is that the US and China avoid these possible traps in the short term, with President Trump set to visit China in the near term and instead use the visit as an opportunity to emphasize cooperation.
Markets in nosebleed territory
The elephant in the room with investors is the seemingly nosebleed levels of the market. At 17.9 times forward earnings, the S&P 500 isn’t cheap; certainly it’s above long-term averages but not yet at troubling levels. While there is little argument that over long periods of time (10-year investment horizon), higher starting multiples for the market imply weaker returns. After all, if you start with high valuations, chances are good that they will not be sustained for long. However, when looking at shorter investment horizons, such as one year, there is absolutely no statistical relationship (analyzed with data from 1964 to present) between starting multiples and the return a year out.
So if there’s no relationship in the short run between starting multiples and the returns a year out, and since most geopolitical shocks tend to have localized impacts and generally are buying opportunities for savvy buyers, investors should consider being largely fully invested with just a little dry powder to pick up some of your favorite names on a dip.
What I Recommend
One thing that consumers are spending on in this market is experiences. Whether it be travel, show tickets or special events, investors seem willing to dig in deep to afford these experiences.
One company that is likely to continue flying high is consumer stock Air Canada (TSX—AC), Canada’s flagship carrier. From its founding in 1937 as a government-owned monopoly to its privatization in 1988 and 1989, Air Canada has grown into one of the world’s largest airlines. Air Canada trades at a substantial discount to peers owing to its leverage and concerns around profit sustainability. The cost-transformation story appears to be in its early days. Should it be fully executed, I believe that a step function re-rating of the shares could occur. There still remains another stage of cost reductions that has yet to be implemented, on top of significantly lower jet fuel prices—which, if sustained, could provide investors another valuation leg higher. I have a ‘buy’ rating and a twelve-month price target of $33 per share for Air Canada.
WestJet Airlines Ltd. (TSX—WJA) is another Canadian airline that has been putting up some solid numbers lately. WestJet offers scheduled service throughout its North America and Caribbean network to over 140 destinations. The company is transitioning into a mainline airline through the roll-out of its wide-body strategy. In May, WestJet announced the purchase of up to 20 Boeing 787-9 Dreamliner aircraft (10 firm + 10 options), with the first ten 787 aircraft to be delivered between 2019 and 2021. WestJet is looking to expand to new destinations in Asia and South America, as well as to increase its service offerings to European destinations. In its most recent quarter, the airline delivered a solid quarter on the back of good cost management. I have a ‘buy’ rating and a twelve-month price target of $30 per share for consumer stock WestJet Airlines Ltd.
One extremely solid name for investors to consider is global financial services stock Visa Inc. (NYSE—V), the operator of the world’s largest retail electronic payment network and manager of the world’s leading electronic payments brand. Through a series of cards and card types, including credit, debit, prepaid, and commercial payments, Visa enables global commerce. Visa is the best player in the space and is driven by a long-term secular growth story. The fundamentals for Visa are exceedingly strong: high-single- to low-double-digit organic revenue growth, 60 per cent+ GAAP operating margins, potential for close to mid-teens-plus earnings per share growth, and significant free cash flow generation place Visa within a very select group of companies with strong fundamentals. Longer term, the company should begin to optimize its capital structure, which could provide additional growth opportunities. I have a ‘buy’ rating and a twelve-month price target of $125 per share on financial services stock Visa Inc.
With strong economic growth globally, and a preference amongst consumers for experiences over things, investors should look to companies that can help fulfil consumers’ demand for experiences. While the markets may be elevated, there is no reason to believe that the party is about to end anytime soon. Investors should still be close to fully invested until the data suggest it’s time for a more defensive posture.
John Stephenson is an award-winning portfolio manager and the President and CEO of Stephenson & Company Capital Management Inc. in Toronto. He is the author of “The Little Book of Commodity Investing” and “Shell Shocked: How Canadians Can Invest After the Collapse.” He is also the publisher of Strategic Investor (www.StephensonFiles.com). He can be reached at (647) 775-8360 or (844) 208-8817, or firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the October 2017/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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