Conventional investing wisdom says that commodities are the best sector to buy during inflationary periods. So Morgan Stanley’s downgrade of the North American metals and mining sector this week came as a surprise to me.
Analyst Carlos De Alba lowered his ratings on much of his coverage universe in a report Wednesday titled Taking Chips Off the Table.
Mr. De Alba downgraded giant Brazilian iron ore producer Vale SA, as well as U.S. aluminum producer Aloca Corp., to “equal weight” from “overweight.” U.S. producer Southern Copper Corp. was cut to “underweight” from “equal weight.”
He noted that while the stocks were attractively valued relative to history, current high commodity prices threatened future demand. The good news, in other words, is mostly priced into the stocks.
There was some encouragement, however, for domestic investors. Mr. De Alba continued to recommend Teck Resources Ltd., with the stock now the only one to garner his “overweight” rating, thanks to its exposure to metallurgical coal as well as plans to expand output.
Demand-push inflation is usually great for mining company profits, but global manufacturing growth is now slowing and an inflationary environment combined with slowing economic growth – stagflation, in other words – is another case entirely.
Mr. De Alba’s analysis of previous stagflationary periods – the mid-1970s, 1985 and also 1992 – found that industrial metals and mining equities in the Americas underperformed the broader equity market by an average of 12 per cent.
This sounds definitively bearish for metals markets but there is an odd ambivalence to Morgan Stanley’s commodity price forecast. Also Wednesday, the firm’s commodity strategist Marius van Straaten wrote: “Although we lift our price forecasts across the board, we have a bearish tilt in our price deck into year-end, as trade flows likely adjust and we see risks to demand.” This sentence, which combines an increase in commodity price forecasts while claiming a “bearish tilt,” is as confusingly contradictory as I’ve ever come across in almost 30 years of reading research reports.
In terms of individual commodities, Morgan Stanley sees a bump in iron ore prices in the next six months as China re-ignites construction growth and then falling demand growth thereafter. The copper price is caught between its importance for the electrification of the global economy and the potential for inflation to slow core (non-food and energy) consumer spending worldwide and crimp demand.
It pains me to use this cliché but the most accurate way to summarize my reaction to Morgan Stanley’s research is that the easy money has been made in metals markets, at least for the time being. Individual producers of the right metals, selling into the right markets, could very well prosper. The sector as a whole, however, is fairly valued; stock prices are balancing the profitability of commodity prices at current high levels with the possibility that these same prices will limit future demand.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
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Ask Globe Investor
Question: I have been watching shares of Shopify Inc. (SHOP-T) drop lower and lower over the past few months. At what point would you consider it a buy?
Answer: Shopify has been an exceptionally volatile stock. Two years ago, it traded for about $500 a share on the Toronto Stock Exchange. It went on to more than quadruple in price, hitting a record high of $2,228.73 in November, before the bottom fell out. On Friday, it was trading near C$843. These dramatic ups and downs tell me two things: 1) Investors have no idea how to value the company, and; 2) Shopify’s share price is driven by momentum trading that is largely divorced from the company’s fundamentals.
But get this: Even after the recent collapse, the shares are still trading at about 185 times the average earnings estimate for 2022, according to Refinitiv. Such a lofty price-to-earnings multiple indicates that huge growth expectations are built into the stock price. If Shopify’s growth disappoints, the stock could be in for more pain.
Adding to the uncertainty, analysts’ price targets are all over the map, ranging from a high of US$1,990 to a low of US$660 for Shopify’s U.S.-listed shares, which is equivalent to about $2,490 and $825, respectively, for the Canadian-listed shares. If analysts can’t agree on where the share price is heading, I sure as heck don’t know.
Given the volatility of individual technology stocks such as Shopify, I believe most do-it-yourself investors are better off sticking with blue-chip dividend growth companies, which are more predictable and generate steady income whether their share prices are rising, falling or going sideways. I still believe it’s important for investors to have exposure to technology stocks, but owning diversified index exchange-traded funds is probably a better way to get that exposure.
What’s up in the days ahead
Magna International’s shares are down more than 30 per cent from their highs last year. Russia is just the latest challenge, with trade issues and rising interest rates (and looming recession) also weighing on the stock. How much bad news is already built into the share price? David Berman will take a look.
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Compiled by Globe Investor Staff