A much-anticipated agreement by the United States and China to resume trade talks has not changed TD Asset Management portfolio manager Michael O'Brien's cautious outlook on the markets.
"This weekend's outcome reinforces that we're in a tricky environment for stocks. We might get a bit more upside here in the near term, but the ongoing trade overhang keeps me cautious on the outlook for the back half of 2019," says Mr. O'Brien, the lead manager of the $3.4-billion TD Canadian Equity Fund and co-manager of about $6-billion across various TD funds.
As part of the latest agreement, reached on the sidelines at the Group of 20 summit in Japan on the weekend, U.S. President Donald Trump promised no new tariffs and an easing of restrictions on Huawei Technologies Co. Ltd., while Chinese President Xi Jinping agreed to make new purchases of U.S. farm products.
“In the short term, this truce – or pause – is positive for markets simply because a worst-case outcome was averted,” Mr. O’Brien says. "But what becomes apparent when you digest this is that, on the truly fundamental areas of disagreement between the U.S. and China, nothing has really changed. We don’t appear to be any closer to a solution.”
Mr. O’Brien says he believes markets “will continue to be wary about the potential for further trade deterioration. Ultimately, I think U.S.-China trade friction will come to be seen by markets as the new reality.”
Over all, Mr. O’Brien believes the best of times have come and gone for the markets this year. “I believe we’ve seen the lion’s share of market returns in 2019.”
He began building more resiliency into his portfolio in May when the U.S.-China trade agreement hit a setback.
“It’s not that we’re overly negative, but after a four-month spurt – where markets were up 15 to 20 per cent and a lot of names that are more dependent on economic growth have crept up to the higher end of their valuation ranges – the fundamental macro outlook appears to have dimmed. We took some profits and downsized in some positions,” he says.
The F-series of his TD Canadian Equity Fund, which is generally available for fee-based advisers, is up 12.7 per cent year-to-date and 3 per cent year-over-year, as of May 31. The fund has a compound annual growth rate of 6.7 per cent over the past three years and 4.4 per cent over the past five years. These returns are after the management expense ratio of slightly less than 1 per cent.
The Globe recently spoke more to Mr. O’Brien about his investing strategy and portfolio moves.
Describe your investing style
We like to think of ourselves as reasonably conservative investors. We have a preference for quality, stable companies that are leaders in their industries. We look for growth at a reasonable price and risk-adjusted returns.
Your Canadian equity fund has 9 per cent U.S. holdings today. Describe why?
We are permitted to go up to 20 per cent [in the TD Canadian Equity Fund]. Historically, we’ve tended to run from 7 to 8 per cent on the lower end and 16 to 17 per cent on the higher side. Nine per cent is on the lower end. We are seeing better opportunities in Canada, where valuations are more attractive. This relates to … sentiment is overly negative, and fears are irrationally high.
What’s your take on whether a recession is near?
A recession is not inevitable. It’s preventable. In my opinion, a recession would be the outcome of a policy mistake, or a series of policy mistakes, tied to trade policy. If we wind up in a recession, it will be because of the actions of government leaders, not in spite of them.
What are you’re selling?
We’ve been trimming names in Canadian tech, which has been red-hot year-to-date, such as CGI Inc. and Constellation Software Inc. The businesses are still performing very well, but are trading at the high-end of their historical valuation range. It’s a similar story with the Canadian railway stocks. It was time to take some money off the table.
What are you’re buying?
We’ve been increasing exposure to sectors such as consumer staples, health care and pipelines. Gold is another area that we’ve become more interested in. One stock we’ve been adding to is Agnico Eagle Mines Ltd. It’s at an interesting inflection point: It spent the past several years building two large mines in Nunavut. With these mines ramping up production, the company is now shifting from an investment phase to a harvest mode at just the right time [as gold prices begin to rise amid economic uncertainty.]
Another company we’ve been adding to it Fortis Inc. It’s a regulated utility with a low-risk business model. It has been a significant laggard year-to-date as people felt they didn’t need to embrace that safety any more. As the readjustments happen … it seemed to be a good buy from a risk-reward perspective and part of our strategy to make the portfolio more resilient because we expect things to get a little choppier for the rest of the year.
What's one stock you wish you owned or didn't sell?
CAE Inc., which provides flight simulation and training, and is a global leader in its industry. We owned it for the first half of the decade as a play on the global recovery, but sold too soon. We exited in early 2016 at $15 a share. We got impatient waiting for the business to start performing to its potential. Earnings have doubled in the past five years. The stock is trading at about $35 today [on the TSX]. I should have been more patient and let the business cycle land.
This interview has been edited and condensed.