Where to Find Value in the TSX?

The tide might be turning for cyclicals, but portfolio managers warn that you need to be very specific as you buy in Canada right now

Yan Barcelo 10 September, 2020 | 12:52AM
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The coronavirus pandemic has affected nearly everyone on the planet. Investors were not immune, and most of us can remember the panic and volatility of March and April. But it has been relatively smooth sailing since, as using the concept of the “pain index”, the COVID-19 bear market goes down in history as one of the least painful on record, lasting a total of about 120 trading days with a maximum drawdown of about 34% - at least in the U.S. For Canadian stock investors, the recovery hasn’t been quite as boisterous. As of August 17, 2020, the S&P/TSX Composite benchmark index is roughly 6% shy of its pre-pandemic highs.

In fact, Stéphane Rochon, vice-president and general manager, portfolio advisory team, at BMO Wealth Management bemoans the situation, saying that the reason for the underperformance “holds with the structure of the market itself”. The TSX, he explains, is a lot less diversified than the S&P 500 and quite low on growth stocks that have outperformed in the last decade.

Secular growth stocks (able to grow in any economic environment) like Amazon, Google and Shopify have steamed ahead while others trailed behind, notably in Canada which has suffered from tepid growth and hyper-cyclical stocks that have been decimated. But the tide might be turning, if you want to buy – but be wary.

“You have to remain very specific in Canada, rather than own the broad market,” warns Paul MacDonald, CIO and portfolio manager at Harvest Portfolio Group. “If Canada benefits, it will be in materials mostly, and potentially in some consumer, energy and industrial plays.”

What to Buy?
With a worldwide stimulus of US$10 trillion to fight the pandemic, about 12% of a global GDP of US$ 85 T, “such public expenses are good for base materials and create a favourable environment for the Canadian marketplace,” claims Rochon.

He points to copper as a prime example. “At US$3 pre-COVID-19, the price of copper has fallen to US$2.10 per pound, and has since rebounded, but interestingly, many stocks have not yet benefited,” Rochon says, pointing to the use of copper in electric vehicle infrastructure. He illustrates his point with First Quantum Minerals (FM), a pure play on copper that has recently initiated the largest new project in Panama. “If the price of copper keeps going up, First Quantum will profit from it,” comments Rochon.

MacDonald talks about gold, that is “helping the TSX at present,” especially with a price per ounce above US$2,000. The sector has very recently received a significant and unexpected vote of confidence with Warren Buffett’s Berkshire Hathaway buying 21 million shares of Barrick Gold (ABX). However, Morningstar disagrees that retail investors need to invest in gold, as the factors that determine a successful investment in gold are extremely difficult – if not impossible – for retail investors to predict.

Another area of interest is lumber and building materials. “Housing starts are extremely strong and favour that sector, indicates Rochon The price for 1000-feet linear board fell at $260 during the crisis but nearly tripled inside a few months at $672, its highest level in 20 years.” He singles out West Fraser Timber (WFT), whose share price has exploded from a crisis low of $24 to $66. “But its high stood at $100 in 2018, so there’s still potential for growth.”

Banks: Buy or Bust?
The two analysts part ways when it comes to financials, a fan favourite in Canada. “We love Canadian banks for their yield, but we expect growth to be muted,” says MacDonald. Rochon is more bullish. “Financials should be helped by the surge in housing and by the recovery, which also helps the rating of borrowers, another factor rooting for banks and insurers,” he says.

Rochon thinks that insurers have been unduly punished by investors who expected a much higher death toll in the pandemic’s wake, imposing a high cost of coverage to the industry. Also, the heavy share of corporate bonds in insurers’ portfolios caused investors to worry that loads of bankruptcies would punish their asset base. “But that didn’t happen, thanks to the stimulus, notes Rochon, who adds: the latest results of insurers were very strong compared to expectations.

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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, writing for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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