The Great Reopening is in the works, and the smart money is getting ready.
Economic readings increasingly portend a growth cycle unlike any other in modern history, once the pandemic finally releases its grip on the world.
Forecasters and investors are madly revising their estimates, and repositioning portfolios, to keep up with the scope of the economic megaboom that is taking shape. Financial markets are seeing a wholesale rotation out of the stocks and sectors that benefitted from pandemic-fuelled lockdowns, and into those industries that have the most to gain from a burgeoning global economy.
Economic results, as well as corporate earnings, are still blowing past estimates by a wide margin. The latest beat came from the Canadian labour market, which added about 260,000 jobs in February, according to Statistics Canada. That result more than tripled the average forecast and practically undid the toll of the pandemic’s second wave on Canadian employment.
“Outside of a major third wave requiring another dose of strict shutdowns, the economy should now be in the nascent stages of its final recovery from COVID-19,” Royce Mendes, senior economist at CIBC Capital Markets, said in a note to investors.
The stock market is also underestimating the force of the snapback, according to Stephen Lingard, the head of investment research of CI Investments’ multi-asset team.
“This is a real, meaningful postpandemic boom, and it’s still not priced in,” Mr. Lingard said, adding that Canadian GDP could grow by 10 per cent this year, before adjusting for inflation.
“Once you see vaccines working and infections really going down, and the economy opening up, that could be a very powerful cocktail for people to bring down their savings rates and really supercharge this economy.”
For investors, that means lots of fuel for the pro-cyclical movement that has overtaken markets since early November, when a number of pharmaceutical companies stunned the world with news that COVID-19 vaccines were far more effective than anticipated.
The development of successful vaccines produced a reversal of fortunes in the stock market, as the worst-performing sectors of the pandemic began to drive returns. The market began to favour value stocks over growth stocks, and pro-cyclical sectors over defensive sectors.
“The rotation out of tech and other growth stocks into cyclical areas of the market has further to run,” Mark Haefele, chief investment officer at UBS Global Wealth Management, said in a recent report.
“We recommend investors tilt their stock exposure to sectors that are likely to benefit from higher growth.”
Below is a closer look at some of the sector, style and stock positions that might be well-suited for a postpandemic honeymoon.
Overweight: Cyclicals, Value, Small Cap, Commodities and Canada
When the broader economy is stagnant, or actively shrinking, investors tend to migrate away from those parts of the market that rely on a backdrop of growth.
This has been the case for much of the past decade, as a slow-growth reality settled on post-global financial crisis markets.
The commodity supercycle ended, sending energy and metals prices into a long descent, while economically sensitive sectors like financials and industrials broadly underperformed. The Toronto Stock Exchange features all of these sectors in abundance.
The pandemic amplified those trends, as investors sought safety in large-cap growth stocks to the exclusion of almost any other investing theme.
Recent months, however, have given value and small cap investors more reasons to be happy than in the previous decade.
Since early November, the iShares Canadian Value Index ETF has returned nearly 30 per cent, compared with roughly 8 per cent for the comparable growth fund, and 16 per cent for the S&P/TSX Composite Index.
A recent RBC Dominion Securities note rated the bank’s best Canadian value picks, with Centerra Gold Inc. , Dundee Precious Metals Inc. , CI Financial Corp. , Kinross Gold Corp. and Keyera Corp. topping the list.
The S&P/TSX Smallcap Index, meanwhile, is up by 34 per cent over the past four months, after having been down by nearly 20 per cent over the previous 10 years. In the U.S., small-cap value is the single best performing equity factor so far in 2021.
“It’s all about earnings,” said Robert Lauzon, deputy chief investment officer at Middlefield Group. “The market is saying we’re going to get a massive year-over-year rebound in earnings.”
Globally, corporate profits in cyclical sectors, including energy, materials, financials and industrials, are expected to rise by roughly 100 per cent this year compared with last, according to Bloomberg data.
The latest earnings season for the Canadian banks, for example, saw each of the Big Six beat expectations, as the group surpassed prepandemic profit levels far quicker than anticipated.
Underweight: U.S., Big Tech and Growth Stocks
For the first time in many years, investors are finding a compelling argument for reducing exposure to the U.S. market.
It was virtually the only market in the world drawing substantial investor interest through the darkest days of the pandemic, as the country’s tech and internet giants assumed an unprecedented global profile.
Since the market turned on growth stocks, however, the previously untouchable Nasdaq 100 index has trailed all kinds of different regions, factors, styles and sectors, including energy stocks.
“The companies that would have ranked at the top of the list last year, like tech companies with visible earnings and those that benefited from the lockdown, they’re now moving to the bottom,” said Christine Tan, a portfolio manager at Sun Life Global Investments Inc.
It’s not that the tech sector has lost earnings power – its profits are expected to rise by around 40 per cent this year. But you can get the same – or better – earnings growth elsewhere, at lower valuations.
“You’re likely to see explosive earnings growth from financials, energy, materials and industrials, on top of the potential for re-rating,” Mr. Lingard said. “You get valuation and excess earnings growth.”
Selective: Pandemic Casualties
The consumer sector is sitting on an enormous cash pile, presumably ready to be spent on all the things people couldn’t do over the past year.
In February, CIBC pegged the excess savings by Canadian households at $100-billion. In the U.S., that figure is closer to US$1.7-trillion. That hoard is likely to grow, with a new round of U.S. fiscal stimulus totalling US$1.9-trillion signed into law by U.S. President Joe Biden this past week.
Combined with an accelerated U.S. vaccine rollout, that makes for a bullish set-up for a number of industries that were hit hardest through the pandemic. “We see the makings of the strongest consumer stock backdrop in decades,” Jefferies chief economist Aneta Markowska wrote in a recent note.
While the Canadian market does not have a huge range of consumer listings, retail-focused REITs in Canada haven’t yet seen a comeback on the same order as their U.S. counterparts, Mr. Lauzon said, naming RioCan REIT and First Capital REIT as top picks.
It’s important to be picky with reopening plays, however, many of which have already priced in a lot of upside. Air Canada shares, for example, are up by more than 30 per cent this year to date alone. “While the stock could have further upside potential in the long term from a full recovery in air travel … at current levels the market is already largely pricing in our base case projections,” Scotia Capital analyst Konark Gupta wrote in a note.
The hardest hit segments of the market will also be those most susceptible to any setbacks in the economic reopening.
“If people lose their immunity quickly, if variants show up faster and are allowed to spread, a lot of this can come undone,” Mr. Lingard said.
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