Graphic illustration of business cycle

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Covid-19 was a mid-cycle “break” for the global economy, says Shah Khan, portfolio manager with Mackenzie Investments. Furthermore, he believes we’ve re-entered the cycle at the tail end.

“This doesn’t appear to be a new economic cycle. Just think of Covid as having temporarily interrupted the old cycle,” said Shah, speaking on the Soundbites podcast. “And with traditional cyclical drivers already at late-cycle highs, it’s difficult to see how we can have robust GDP growth going forward. So, our thesis right now is we’re expecting a slowdown over the next several quarters.”

According to Shah, the Covid years looked “nothing like a typical recession” where economic problems cause employment to fall, risk appetite to decline, consumer spending to dry up and GDP to shrink.

“Covid was very unusual in that none of that actually happened. The economy was essentially forced to shut down, causing it to contract significantly. And as it reopened, it snapped right back,” he said. “So, we had rapid job gains, extremely strong housing, strong consumer [spending], and right now we’re back on the trendline for GDP that began following the financial crisis.”

Headwinds to growth

Shah said inflation remains the greatest threat to economic growth.

While initially thought to be temporary, inflation was further fuelled by a war that halted critical exports from Eastern Europe.

“We had begun to see early signs of global supply chains turning the corner,” he said. “Companies were calling for improvement in the second quarter, and a substantial improvement in the second half of 2022. [But] then you had the Russian invasion of Ukraine. And this has materially increased the inflationary risk to the global economy. It just kind of pushes that timeline out further.”

Worse, while inflation initially primarily affected commodities prices, it is now becoming unrestrained.

“We’re now seeing inflation spread into things like services and, more importantly, wages,” he said. “And, related to that, you have the central bank’s response. The risk we see is a central bank-induced recession.”

Aggressive economic moves could tip the U.S. into recession, he added.

“Raising rates at this point in the cycle, we think, will likely cause some demand destruction. We expect to see weakening consumption and lower economic growth going forward. And this doesn’t take into consideration the fact that consumers right now are so much more indebted than they were pre-Covid,” he said.

Companies he likes

In such challenging conditions, he’s looking for companies with free cash flow, strong balance sheets, prospects for growth and, most importantly, pricing power.

“It’s very important to own businesses that have pricing power. That allows them to preserve margins, to offset inflation,” he said, pointing to Montreal-based Canadian National Railway Co. and Calgary-based Canadian Pacific Railway Co. In Canada, rail shipping “is a duopoly market structure [with] high barriers to entry, and it gives them tremendous pricing power.”

He also likes companies insulated from supply chain issues. A good example is Vancouver-based Telus International, a subsidiary of TELUS Corp. that provides IT services and multilingual customer service to global clients.

“They’re benefiting from one of the broader macro themes of increased digitization, being wherever the customer is, interacting however the customer wants,” he said.

Finally, he likes businesses with strong management teams and a track record of strategic execution.

Shah said Premium Brands Holdings Corp., a specialty food manufacturer based in Richmond, B.C., has not only benefited from a shift to healthier eating, but has also endured Covid-related shutdowns extremely well.

“They’ve just done a phenomenal job, offsetting some of the softness in the end-markets like restaurants, redeploying that capacity to other channels, which were very strong through Covid, like groceries,” he said. “They also retained all of their employees through Covid, to be better prepared when demand does come back.”

Key takeaway

Shah emphasized that valuation is a critical tool for thriving in uncertain economic times.

Stable growth above market rates and through a cycle, strong balance sheets, and significant free cash flow “provide downside protection to the portfolio when headwinds do emerge,” he said.


This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.

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