Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s Soundbites, we speak with Shah Khan, vice president and portfolio manager with the Mackenzie Bluewater Team. We talked about current economic headwinds, and companies he likes. And we started by discussing where we are in the business cycle.

Shah Khan (SK): Where are we in the cycle is the million-dollar question. We think we are in the late stages of the cycle, and there’s a few reasons why we think that. So, what happens in a typical cycle? Well, unemployment drifts lower, people have jobs, they spend money, causing GDP to expand. Then you run into economic problems, consumers, businesses pull in their horns, risk appetite dries up, unemployment increases, and GDP takes a step down. So, you get a recession. Then the cycle starts all over again. So Covid was very unusual in that none of that actually happened. The economy was essentially forced to shut down, and as it reopened, it snapped right back. And right now, we’re on the trendline for GDP that began following the financial crisis. So, it doesn’t appear to be a new economic cycle. Just think of Covid as having temporarily interrupted the old cycle. So, with cyclically low unemployment, record housing prices, strong consumer, what’s going to be the thing that drives growth further? And that’s the big question we have. That’s why we think that this is the late stages of an economic cycle.

Headwinds to economic growth.

SK: Yeah, look, there’s always a laundry list of issues that we worry about, and this time is no exception. One of the areas is obviously inflation. What happened through Covid was that consumer spending patterns shifted dramatically, from categories like travel, tourism, entertainment, to durable goods. It is roughly 20% above normal levels. Now that’s all great, but the problem is that global supply chains were simply not built to accommodate such a shock in demand, and they struggled to keep up. As spending normalizes, we should expect these issues to resolve. And we had. Companies were calling for improvement in (the) second quarter, and then a substantial improvement in the second half of 2022. Then you had the Russian invasion of Ukraine. And this has materially increased the inflationary risk to the global economy. And it just kind of pushes that timeline out further. The other thing is we’re seeing inflation spread into things like services and, more importantly, wages. Now, related to that, you have the central banks’ responses. And the risk we see is a central bank-induced recession. They’re moving aggressively on rates. And we think that aggressive moves will ultimately cause demand destruction, and we expect to see weakening consumption and lower economic growth going forward.

Companies he likes.

SK: In light of the cost pressures, it’s very important to own businesses that have pricing power. That allows them to preserve margins, to offset inflation. So, think of rail. In Canada, you have CN [Canadian National Railway, based in Montreal] and CP [Canadian Pacific Railway, based in Calgary]. It’s a duopoly market structure, rational competition, high barriers to entry, and it gives them tremendous pricing power. And that’s very important in this environment. Second, a lot of the issues we’re seeing right now around supply chain, chip shortages, commodities inflation, it tends to impact goods-oriented businesses. Service-oriented companies, however, they’re largely immune from this. So, [Vancouver-based] Telus International, great example. They’re benefiting from one of the broader macro themes of increased digitization. Companies that are recognizing the importance of an omnichannel offering: bricks and mortars and online presence. So being wherever the customer is, interacting however the customer wants. Telus International enables all that. Also, we like businesses that have strong management teams with a strong track record of execution. So, an example? Premium Brands, the specialty food manufacturer [Premium Brands Holding Company, based in Richmond, B.C.]. They have a business segment, their food services segment, which was significantly impacted through the lockdowns. And management, they’ve just done a phenomenal job offsetting some of the softness in the end-markets like restaurants, redeploying that capacity to other channels like grocery. They also retained all of their employees through Covid. So, a lot of blocking and tackling and it really highlights the strength of the management team and their long-term focus.

And finally, the key takeaway on where we stand after Covid.

SK: In light of all this uncertainty, what I would say to investors is what you own becomes very important, valuation becomes very important. So, businesses that exhibit stable growth above market rates, through a cycle, strong balance sheet, and that generate significantly free cash flow, these attributes provide downside protection to the portfolio when headwinds do emerge.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Shah Khan of the Mackenzie Bluewater Team. Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.


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