Canadian Stocks Well-Positioned for Post-Pandemic Recovery

Rebounding global economies, increased demand for commodities and attractive valuations in Canada’s equity market are setting the stage for a strong second half of 2021.

Garey J. Aitken

Garey J. Aitken Chief Investment Officer,Franklin Bissett Investment Management

Tim Caulfield

Tim Caulfield Director of Equity Research,Franklin Bissett Investment Management

This time last year, as we reflected on one of the largest market corrections in history, an end to the pandemic seemed a long way off. We are now halfway through 2021, and thankfully, a world without COVID-19 dominating our lives looks much closer due to the success of the vaccine roll-out so far.

Of course, with new variants continuing to emerge, we are far from out of the woods yet, but optimism for a post-pandemic future is growing. That’s reflected in the International Monetary Fund IMF forecast for global growth (6% in 2021; 4.4% in 2022), as well as the health of equity markets.

Here in Canada, the S&P/TSX Composite TRI reached a new record high on May 18, 2021, and as of Q1 2021, had recorded four consecutive quarters of positive returns following the severe drawdown of Q1 2020. In fact, the main Canadian index outperformed the S&P 500 during the first quarter (7.3% versus 5.8%), which was a regular occurrence between 2000 and 2010, but rare in the subsequent decade.

A new commodity supercycle?

The strength of commodities certainly bodes well for the Canadian market going forward. Copper, lumber and iron ore are currently trading at all-time highs, while agricultural commodities have also surged this year. The Commodity Research Bureau Index was up 52 % year-over-year on April 30, 2021, having plummeted during Q1 2020 to its lowest level since 2009.

An export economy, Canada will benefit significantly from this uplift in commodity prices, particularly its energy sector. Having seen oil futures for Western Canada Select fall into negative territory in April 2020, a barrel now trades above US$50. Higher oil prices also mean a stronger loonie, which breached the 83 cents mark in May (a six-year high), having fallen as low as US$0.67 last year.

Whether the reversal of fortunes for oil, alongside rising prices for the other resources, is part of a new commodity supercycle is open to debate. The previous supercycle occurred in the first decade of the new millennium, fueled by the rapid expansion of the Chinese economy. Canadian stocks benefited tremendously from increased demand for commodities during the period, and that remains the case today, for China and every other country that require resources to build infrastructure and boost their economies.

Value in Canadian stocks

The strong performance of the S&P/TSX Composite TRI during Q1 came during the honeymoon period of Canada’s vaccination program.

How fast the global economy ultimately recovers depends largely on how effective the various COVID-19 vaccines are in combatting the virus, and not just in the wealthy western nations, but the developing world as well. If 2021 is indeed the year we can turn the tables on the pandemic, then expect commodities to continue to be in hot demand and Canada to benefit.

Another factor to consider is the valuations of Canadian stocks. After the drawdown last year, the rebound in equity markets was driven in large part by momentum and potential and less so by fundamentals and valuations. The impetus of this narrow range of highly valued companies slowed in Q1 2021 as investors started favouring more on fundamentals and cyclical names that are likely to benefit the most from an end to lockdowns. That trend wasn’t as apparent in Q2, but if we are able to move past the cycle of lockdowns in the second half of 2021, the Canadian equity market should benefit from rebounding global economies and attractive valuations..

S&P/TSX COMPOSITE TOTAL RETURN INDEX BREAKDOWN BY SECTORChart Sub Title

As of April 30, 2021

From bull to bear and back again

After a record-breaking bull run that fell just short of 11 years, the bear market was short lived, lasting just over a month (February 20, 2020 to March 23, 2020). The declines during that period were eye-watering, but the response since then has been robust. The new bull market YTD has produced a S&P/TSX Composite TRI return of 67.20% compared to -37.20% during the bear market.

So far in 2021, every sector bar materials has posted a positive return, with health care, energy, consumer discretionary, financials and real estate all posting double-digit returns. The year began with markets behaving much as they have been for most of the past decade—growth stocks outperforming value names and momentum and potential being favoured over fundamentals and valuation. In the latter half of the first quarter, with inflation expectations rising and interest rates rebounding off recent lows, equities with stronger near-term fundamentals and more reasonable valuations garnered more investor attention.

In Energy, the sector’s advance was aided by a 21.9% rise in crude oil to finish the first quarter at US$59.16 per barrel (West Texas Intermediate ) and a 2.7% advance in natural gas to US$2.61 per mmbtu (NYMEX). Using the past 12 months for guidance, it is clear that volatility is going to be a feature of the energy sector going forward given the global shift towards decarbonization. Regardless, we remain confident in the prospects of a number of companies we hold to adapt to the challenging business environment for oil and gas producers, including Tourmaline Oil Corp. (55.6% YTD) and Keyera Corp. (27.4% YTD).

After a difficult time in 2020, the financials sector has responded well in 2021. Robust returns in the sector were broad-based as several constituents seemingly benefitted from a sentiment shift driven by higher interest rates.

In response to growing expectations for federal legalization of cannabis by the Biden administration in the U.S., the health care sector in Canada was boosted by several cannabis-related equities such as Aphria (114.6% return YTD). We continue to be underweight in this sector.

Materials, the only sector to produce a negative return YTD, has been hurt by the decline in precious metals as the price of gold and silver fell 9.6% and 7.1% to US$1,714 per ounce and US$24.53 per ounce, respectively, during the first quarter.

Comparing the new bull market overall and 2021 YTD, the largest swings have occurred in consumer discretionary and information technology. Weakness in IT has been largely broad-based, including benchmark-heavy Shopify, which was the undoubted success story of 2020, but has since struggled to maintain that momentum in 2021.

An end to stimulus and finding value

Should the pandemic be brought to heel later this year, the unprecedented fiscal and monetary stimulus that has characterized this crisis will wind down. When this occurs, we believe market participants will adopt a more balanced view and discerning approach towards valuations.

Throughout the pandemic our underlying businesses have performed well from an operating and financial perspective, and we are increasingly confident in our funds’ relative return potential, given how much the stimulus measures affected corners of the market.

It is during times like these that we are reminded of the importance of not getting too high or too low through varying market regimes. We keep our focus on a long-term view that cuts through the ebb and flow of financial market sentiment. The discipline and consistency developed over multiple market cycles, and the patient, yet decisive, temperament of the team is critical and present today.

We recognize the inefficiency of markets, especially in the short term, and keep our sights set on normalized full-cycle economics of businesses over the long term.

Our investment style is well suited to changing dynamics that directly impact the handicapping of risk and reward potential that is vital to our investing success. Based on our long-term and risk-aware mindset, and the market’s remaining disregard of fundamentals and valuation in favour of momentum and potential, we continue to emphasize valuations and are selective with growth. In recent years, this has detracted from our funds’ relative performance, but we expect this to normalize to our advantage over time.