Equity Commentary: As at June 30, 2021
Source: David Picton | Jeff Bradacs, CFA | Michael Kimmel, CFA | Michael Kuan, CFA | Travis Irwin, CFA
Publish Date: Jul 15, 2021
While equity markets grinded higher during the quarter, beneath the headline index levels there was a rotation in the market as investors weighed concerns of peak economic growth, higher inflation, peak monetary and fiscal stimulus.
Fiscal support peaked in March with US$1.9T going direct to US consumers, ISM manufacturing also appears to have peaked in March and short-term indicators on inflation also appear to be petering out. China already seems decelerating although the rest of world will likely show acceleration as they emerge from lock down conditions. However, the likelihood of some sort of corrective action in risk assets has increased especially as investors start to worry about tightening monetary policy conditions in the US. Pullbacks should be shallow though given the long runway to economic growth against the backdrop of generally stimulative conditions.
As we transition to more of a mid-cycle framework, multiples tend to correct. The ability of companies to execute will become paramount. It is conceivable that companies have overearned in the past 12 months as costs were significantly reduced during the pandemic. Those costs could re-appear with re-opening and will be something to watch for.
Within our hedge equity portfolios, we have reduced our net exposure to cyclical names in favour of quality and growth at a reasonable price (GARP) components -two factors that tend to fare well as we transition to the mid-cycle. The one area of exception is commodities which we continued to have a favourable view with demand rebounding as economies reopen. Meanwhile supply remains constrained as commodity producers across both base metals and oil & gas remain disciplined on raising production.
Small Cap Spotlight
A small cap company we are increasingly positive on is Home Capital Group Inc (HCG). Home Capital offers residential and non-residential mortgage lending, securitization of residential mortgage products, consumer lending services, and offers deposits through its Oaken Financial brand. During the pandemic, the federal regulatory body governing financial institutions in Canada (OSFI) set capital constraints on Canadian financial institutions including HCG to ensure financial stability through the unprecedented times. Those constraints, which prohibited dividend increases and share buybacks, have been in place since March 2020 but could be relaxed in the second half of 2021. Home Capital currently has a Common Equity Tier 1 (CET1) ratio that is well above their targeted levels (currently at 21% vs. targeting 14-15%), and once these restraints are lifted by OSFI we expect the company to return meaningful amounts of capital to shareholders via dividends and buybacks. Given the strong capital position of the company and discounted valuation relative to the peer group, we are positive on shares of HCG.
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