BMO Capital’s Brian Belski says uncertainty from COVID-19 has shifted investor preferences. But as markets pivot from chaos to coexistence, Canadian stocks will participate.
There is no doubt about it. US stocks have exhibited an epic price recovery that not only is unprecedented but tests most major academic and common-sense assumptions. While “momentum” is the easiest label to qualify the ascension in asset prices since the March 2020 lows, ‘wherewithal’ is another. From our lens, it is precisely the resourcefulness of US companies, let alone society itself, to adapt and improvise—a ‘pivot’ that does not easily show up in a quant screen, macro model, or valuation metric.
Bear markets and recessions create despair, and from despair comes hope. Part of that hope with respect to stock market performance comes from new leaders, new concepts and new themes. The initial chaos that COVID-19 impressed upon the world has clearly defined the beginning stages of transition from despair to hope—the very ‘pivot’ that has led and defined the recovery in stock prices. In other words, we believe stocks are telling us that a pivot from chaos to coexistence is well under way, and investors should act accordingly.
As such, we believe it is extremely difficult in the current environment to employ a market forecast ruled by traditional academic variables. Yes, risk premiums, risk-free rates, earnings growth and valuation metrics are not as meaningful over the intermediate term as process-driven strategists like ourselves would prefer.
Bull market is alive and well
However, the wherewithal of stocks, companies and investors should not be discounted, hopeful and real-life variables that we believe will continue to fuel higher stock prices over the next 12 months. As such, our 20-year secular bull market thesis is alive and well, with March 23, 2020 representing the ‘ctr-alt-del’ reset for the second half of the bull market that is sure to be different than the first half, but one that will equally torment the naysayers and perpetual haters.
Bottom Line: We are re-instituting our calendar year S&P 500 Index price and earnings targets and updating our associated next-12-month forecasts.
Looking ahead, the underlying fundamentals for sectors, the overall market, and the broader economy have certainly been impacted, and new leaders, concepts and themes have been developed which potentially could have long-lasting effects on US stocks. As such, in our US Strategy Comment published on Aug. 28, along with reinstating our S&P 500 2020 year-end price and EPS targets and updating our next 12-month forecasts, we also made four key changes to our US sector recommendations, which are listed below.
As a follow-up, we want to provide further insight into our underlying rationale for each of our sector recommendation changes and highlight some of the analysis used to arrive at our opinions, which can all be found in this report.
US sector changes
■ Upgraded Consumer Staples to Market Weight From Underweight
■ Downgraded Energy to Underweight From Market Weight
■ Downgraded Industrials to Underweight From Market Weight
■ Downgraded Real Estate to Market Weight From Overweight
US sector recommendations
■ Overweight: Communication Services, Consumer Discretionary, Technology
■ Market Weight: Consumer Staples, Financials, Health Care, Materials, Real Estate, Utilities
■ Underweight: Energy, Industrials
Canadian sector changes
■ Energy and Real Estate—Downgrade to Market Weight From Overweight
■ Cyclical rebounds with fewer structural issues can be found elsewhere (e.g., Financials, Discretionary and Tech)
■ Consumer Staples—Upgrade to Overweight From Market Weight
■ While sector valuations are stretched, secular themes within staples retailing are powerful
Canadian sector recommendations
■ Overweight: Communication Services, Consumer Staples and Financials
■ Market Weight: Consumer Discretionary, Energy, Industrials, Information Technology, Materials, Real Estate and Utilities
■ Underweight: Health Care
While Canadian stocks have certainly exhibited an epic price recovery from the March lows, the challenges of the two largest sectors (Energy and Financials) have seen the TSX decouple from the US. In fact, while the US is already above pre-COVID levels and hitting new all-time highs, the TSX remains almost seven per cent below the previous peak. However, with the strong momentum and wherewithal exhibited by stocks, companies and investors since the market lows, we believe these more challenged sectors, particularly Financials, are likely to gain momentum and add fuel to the TSX price performance over the next 12 months.
Financial stocks recovery will soon kick in
Indeed, we expect Financials will eventually participate in the recovery with much higher conviction than is currently priced in, and when it does, the TSX is likely to see strong outperformance and hit new all-time highs. As such, our new 2020 year end S&P/TSX index price target is 18,200, which is just above the previous market high of 17,944 set on February 20, 2020.
Furthermore, we expect this momentum to continue into 2021 with our 12-month forecast adjusted to 18,700. No doubt the uncertainty and chaos that COVID-19 impressed upon the world has shifted investor preferences, but as the market continues to pivot from the chaos to coexist we believe Canadian stocks will ultimately participate.
Although both Energy and Real Estate offer significant value in a market that is now approaching new all-time highs, we believe structural issues that have developed over the last few quarters (lower for longer oil prices, and shift to work and shop from home) are likely to persist and limit any contrarian recovery. As such, we downgraded both sectors to Market Weight as these sectors are likely to move to restoring operating efficiency in the face of these challenges. We also upgraded Consumer Staples to Overweight given the relatively stable earnings, strong secular trends and pricing power that we believe is likely to persist.
Brian Belski is the Chief Investment Strategist and leader of the Investment Strategy Group at BMO Capital Markets. In his more than 30 years in the investment industry, Brian has held various senior strategy and research roles, including positions at Oppenheimer & Co., Merrill Lynch, and Piper Jaffray. Brian is frequently quoted in the financial press, including regular appearances on CNBC and BNN.
This is an edited version of an article that was originally published for subscribers in the October 2, 2020, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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