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Equity Commentary: As at June 30, 2020

Source: David Picton | Jeff Bradacs, CFA | Michael Kimmel, CFA | Michael Kuan, CFA
Publish Date: Jul 16, 2020

Canadian Equities
 

  • The Canadian equity market (S&P/TSX Composite Index) continued to rally in June up 2.5% led by Information Technology (+13.5%) and Materials sectors (+4.5%). Strength in Informational Technology continues to be dominant by gains in Shopify Inc., Canada’s largest company by market capitalization, as shares continued to be driven by the acceleration of e-commerce adoption by consumers globally. Within Materials, Gold prices reached an 8-year high as investors flocked to it as a safe haven due to COVID-19 uncertainty and concerns around the secondary impact from massive global monetary stimulus. Within the Canadian portfolios we continue to have a positive bias towards both sectors.
 
  • Since the March lows, leadership in the S&P/TSX Composite Index has followed past bear markets bottoms with cyclicals outperforming the market with quarter-to-date returns in Materials (+42%), Energy Exploration & Production (+31%), and Consumer Discretionary (+33%). One exception in this cycle vs. past cycles is the underperformance of Canadian Banks. While banks are up from the March lows, (+5% QTD) they have lagged recovery. We continue to believe credit risk, low interest rates, and the economic backdrop will weigh on results and challenge their ability to reach preCOVID profitability levels.
 
  • As we enter Q2 earning season, we expect most companies to deliver trough earnings as much of the global economy was closed due to COVID-19 during the quarter. We expect investor’s focus to be on company outlooks and how they view the pace of recovery for their industry and their ability to adapt to the new environment. The one exception would be the Consumer Staples sector which will likely have peak earnings due to the consumer pantry loading, however, post this quarter earnings momentum will decelerate going forward which we expect will limit their upside relative to the market.
 
U.S. Equities
 
  • The prospects of a Democratic sweep in the November election is fast gaining traction in the marketplace. The presumption, as a result, is that taxes will go up and so too will policies around wealth re-distribution. We believe these conclusions are pre-mature. All of this can certainly happen, but it is unlikely in 2021 in our view. Increasing taxes, redistributing wealth and regulating the technology industry would immediately send a fragile economy right back into recession. These issues are most likely addressed in 2022 under a Biden presidency.
 
  • As we enter earnings season amidst a widening gap in the growth versus value debate, a recent CIO survey of IT spending intentions caught our eye. According to Morgan Stanley, budgets are expected to decline 4.4% on a year-over-year basis in 2020¹ marking the first expected budget decline in more than 10 years and compares to a 3.5% year-overyear decline in the Q1’09 survey. While long term secular catalysts remain in place, the question is whether near term investor expectations are properly calibrated for the severity of these deteriorating spending intentions, particularly in more frothy areas of the market such as software.
 
  • 78% of stocks in the S&P 500 now have a dividend yield in excess of ten-year Treasuries. With the U.S. Federal Reserve happily backstopping financial markets and the U.S. government likely to step up with additional fiscal support in the coming weeks, there are few alternatives to stocks. Therefore, despite increasingly unsettling COVID-related headlines, we expect markets to consolidate recent gains and pullbacks should be used as opportunities to get more cyclical within the portfolio.
 
Global Equities
 
  • Despite concerns about rising U.S./China tensions, Chinese stocks have outperformed this year and continued to do so in June. A number of contributing factors have led to this outperformance: China seems to have controlled the COVID-19 outbreak earlier, the government’s property speculation restrictions have pushed some capital flow in the equity market, and international investors have started to increase their exposure to China. While the media has focused on the government’s support for the equity market and the growth in new account opening and margin buying as the driver of strong performance, foreigner investors are barely mentioned. However, this flow has been significant and could continue for some time. Investors are waking up to the reality that the Chinese equity market is vastly different from the pre-financial crisis (of 2008). The MSCI China now has almost a 60% weight in rapidly growing sectors such as consumption (domestically focused), internet, and technology. These are predominately private companies that generate much higher return on equity than the State Own Enterprises. Many of these high growth companies are trading at a discount relative to the global peers. We have increased our exposure to many of the leading e-commerce, video platform, and e-health/biologics stocks in China.
 
  • We have seen renewed interest in Europe over the past month. It looks like Europe has turned the corner on the first wave of COVID-19 and we are starting to see better employment data and a rebound in retail sales in the key markets like Germany, France, and the UK. However, the big catalyst for the market will come from the EU Recovery Fund, which could be approved as early as mid-July. It is the large and dynamic policy response that investors have been waiting for. The Recovery Fund is expected to place emphasis on major green initiatives. We have increased our positive outlook on companies that we closely follow focused on renewables and energy efficiency. We believe that these companies will benefit from the expected policies as well as the continuing interest and flows into ESG funds.
 
  • Given the uncertainty in the economy, many consumers have traded down over the past few months. One of the key beneficiaries in the UK has been B&M European Value Retail S.A. (B&M), a large discounter of branded non-perishable products. In its core UK business, the company saw 27% like-for-like year-over-year growth from April to June. B&M can sell its products at significantly lower prices than the larger grocery peers because of its direct sourcing, high turnover, and quick SKU change model. They also have a good history of customer retention once an individual starts shopping at B&M, so we expect some of their recent gains to be permanent.
This material has been published by Picton Mahoney Asset Management (“PMAM”) on July 16, 2020. It is provided as a general source of information, is subject to change without notification and should not be construed as investment advice. This material should not be relied upon for any investment decision and is not a recommendation, solicitation or offering of any security in any jurisdiction. The information contained in this material has been obtained from sources believed reliable, however, the accuracy and/or completeness of the information is not guaranteed by PMAM, nor does PMAM assume any responsibility or liability whatsoever. All investments involve risk and may lose value.

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