Equity Commentary: As at April 30, 2020

Source: David Picton | Jeff Bradacs, CFA | Michael Kimmel, CFA | Michael Kuan, CFA

Publish Date: May 13, 2020

Read Time: 8 minutes

Canadian Equities

The S&P/TSX Composite Index continued to move higher over the past two weeks (+4%). Strength in secular growth leaders continued with Information Technology the top performing sector. One key difference relative to the previous update is that early cyclicals started to outperform with strength in Consumer Discretionary, Forest Products, and Base metals. The outperformance of these sectors is in line with leadership trends coming out of previous bear markets.

Over 100 companies representing about 45% of the S&P/TSX Composite Index reported over the period. Given the uncertain environment, most companies removed guidance for the year. We expect that Q1 and/or Q2 to be trough earnings for most companies. However, one group we remain cautious on is Consumer Staples as Q1 benefited from pantry loading and we expect a deceleration in sales momentum with the group trading at peak multiples and on peak earnings.

April economic data including job losses were bleak but have likely troughed as several countries and US states have reopened their economies. While the pace and shape (“V”, “U”, “W”, or “L”) of the recovery by the consumer remains uncertain, early high frequency data (Google & Apple Maps) highlights consumers are active but avoiding crowds like public transit and instead driving more with an increase in consumer miles driven. As a result, we expect to see a sharp recovery in companies like fuel distributors and collision repair centers.

Lastly, the Fund remains steadfastly dedicated to our core momentum-based investment discipline.

U.S. Equities

How can we have lost 21M jobs in the month of April, seen the unemployment rate go from 4.4% to 14.7% resulting in the weakest labour market since the end of the Depression in the 1930s and yet we have a stock market that is 32% off its lows and is only down 13.8% off all-time highs, not to mention the Nasdaq positive on the year? The answer: offside positioning and unprecedented policy action from central banks and governments. Should markets continue their drift higher at the same time as volatility declines, there is risk of further buy in from systematic investors. Cash positioning remains elevated and flows are going into defensive asset classes. Oddly, buyers live higher. On the policy front, at 44% of GDP the combined stimulus from the U.S. Federal Reserve (Fed) and Washington have likely taken left tail risk off the table. The Fed has ensured a functioning credit market allowing even the most challenged of the business to raise capital and extend lifelines. We think should a second wave occur, government officials would willingly re-up on stimulus efforts.

The story on profits is much more ambiguous. There is tremendous concern about the pandemic and unemployment levels for the U.S. consumer and rightly so. Do we really have a good view of what 2021 earnings will look like? People are evaluating them based on 2019 earnings in a normalization exercise but is that fair and what should the multiple be on those earnings? The election is going to matter. The 2021 backdrop will likely include higher taxes and a potentially stronger regulatory regime. This means the chances for upside next year are likely diminished and this is why the near-term upside is constrained. Said another way, 2020 will be the year of the bailout and 2021 is the year that corporate America has to pay the bill via higher taxes. It could very well be that earnings don’t go down as much this year and don’t go up as much next year.

On pullbacks, our intention is to complement our growth and quality positions with more cyclicals though focusing more on the consumer cyclical side than the industrial cyclicals. Consumer cyclicals are direct beneficiaries of where the stimulus is being directed and have the potential to double or triple overtime assuming COVID outcomes are positive. Industrial cyclicals are more reliant on the launch of a large scale infrastructure bill and we are doubtful we see that in 2020.

Global Equities

The economic data and earning season out of Europe has been the weakest amongst all the regions. Eurozone Purchasing Manager Index (PMI) plunged to 13 in April, while all the other major economies reported levels in the high 20s. Much of this weakness is evident in reported corporate earnings where average revenue fell by 7% year-over-year while earnings per share (EPS) plunged by over 30% during this period. The cyclical companies fared a lot worse with average earnings down by over 50%. The banks are in particularly poor predicament given poor demand, weaker credit, and low rates. We have negative outlook in this sub-sector.

The European Auto sector outperformed over the past couple of weeks. Speculation about a cash for clunkers (auto scrappage) scheme heated up with all the major German auto OEMs meeting with the government to discuss ways to spur demand. The 2008/09 program resulted in 4 million new auto sales, with the bulk of the volume going to the mass producers. It is expected that any new plans will place an emphasis on lower Co2 emission.

Tension between the US and China have started to heat up again. Whether this is more politically motivated remains to be seen. However, it should be pointed out that China still has considerable room to support its economy should the relationship deteriorate further. So far, China’s fiscal stimulus package as a % of GDP is only 2.4%, compared to the 8.3% spending in the US and the 12.7% it spent during the great financial crisis. We would expect further interest rate cuts, reserve requirement ratio (RRR) cuts, credit expansion, infrastructure spending, and property loosening polices. These stimuli will be focused on supporting domestic growth and help companies.