Why investors should look beyond macro

As uncertainty regarding inflation, interest rates and overall demand lingers, the global outlook is starting to weaken, according to a portfolio manager from CIBC Asset Management.

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“I’ve turned more cautious in my near-term outlook,” said Craig Jerusalim, senior portfolio manager of Canadian equities at CIBC Asset Management, in an interview on Mar. 7.  

Because of the lag from the time rates rise until to when they stifle demand, Jerusalim said the economy is only just starting to feel the full brunt of the monetary tightening that has taken place over the past year. He was speaking before the collapse of Silicon Valley Bank and the liquidity crisis that’s followed.

Although the jobless rate started the year at record lows and the overall health of consumers started strong, Jerusalim said that’s starting to change. Company management teams have also expressed a cautious tone. 

But while Jerusalim admitted that he spends time worrying about the macro outlook, “the vast majority of our efforts are spent seeking out the companies that are best in class with sustainable competitive advantages and quality attributes that can thrive regardless of the picture that the market is currently painting,” he said.

Jerusalim pointed to three factors that drive equity markets: sentiment, as reflected in valuation multiples; company earnings, driven by revenue and margins; and future growth, which is idiosyncratic and sector dependent.

“When you look at stocks through this lens, the story is somewhat nuanced, but definitely not all bad,” he said. 

Gains early this year pushed the S&P 500 back above its long-term average multiple, he said. In comparison, the TSX appears cheap, and unless a recession is much worse than anticipated, Jerusalim doesn’t see valuations dropping further.  

He said the rally experienced at the beginning of the year was low quality. Stocks that performed the worst in 2022 saw the biggest bounce back.

For this reason, Jerusalim is looking to mispriced growth stocks — “not the unprofitable, long-duration growth stocks that led in 2020 and 2021, but high-quality businesses that have growth characteristics greater than the overall market, and are surprisingly trading at valuations cheaper than the overall market,” he said.

“This is a great setup for patient investors willing to ignore market timing signals and instead focus on sectors and stock selection as their main source of alpha.”

As the economy slows and revenues fall, Jerusalim said earnings will likely start to contract. However, he said many companies have had time to prepare for a slowdown and this is part of the “evolving, rolling economic cycle and nothing overly concerning.”

He predicts the most attractive opportunities are in energy. On the supply side, investment into new projects will likely be curbed due to environmental uncertainty, NIMBYism and more consideration for indigenous communities, he said. 

Shale growth is also hitting hurdles, he said. Investors are demanding cash flow to be returned in the form of dividends and buybacks, starving companies of future production growth.

“Any company that announces major investments at the expense of a return would suffer harsh consequences from fickle investors today,” he said.

These two dynamics have also allowed OPEC+ to “begin acting like the cartel that they are,” Jerusalim said. If demand falls, OPEC+ can cut production knowing that North American producers won’t be able to steal the market share as they have in the past. 

The last piece of the puzzle is valuation, he said, which looks somewhat positive. Although many of the highest-quality producers in Canada are still trading near trough valuations, companies like Canadian Natural Resources Ltd., Tourmaline Oil Corp. and Cenovus Energy have mostly paid down their debt, meaning that nearly 100% of the cash flows are returned to shareholders in the form of dividends and buybacks.

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