Get recovery ready

Brian Belski

Managing Director, Chief Investment Strategist, BMO Capital Markets

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As investors struggle with continued market volatility, Brian Belski, Chief Investment Strategist at BMO Capital Markets, cautions Advisors to look beyond the negative headlines, and focus on the fundamentals – sharing his bullish views on the road ahead for both U.S. and Canadian stocks.

Turn off the rhetoric

Even though the world has previously experienced pandemics, economic recessions and bear markets, we have not had to live these events in today’s “hyper-information” age. That is why reactions, rhetoric, misinformation, emotion and fear have reigned supreme in current markets, while investors and society at large cope with the real-life consequences of COVID-19. The investing world tends to seek historical parallels, but in our view, this virus has NONE. Yet that has not stopped economists, strategists, companies, investors AND the media from extrapolating prior recessions and depressions onto the current situation – a tactic that we believe is misguided and disingenuous. Many are fixated on not wanting to be wrong – and proving it – instead of the desire to be right. Ultimately, this overreliance and focus on macro and quant investing has buried investors, and led to secular underperformance, providing an opportunity for longer-term, thematic and bottom-up portfolio management. It’s time for investors to turn off the noise, and forget trading off headlines.

Reactions, rhetoric, misinformation, emotion and fear have reigned supreme in current markets.

The secular bull is alive and well

While this has arguably been the most hated bull market in history, we believe it’s still taking place: we’re in the middle of a 20-year secular bull cycle. There is no denying that stocks have endured an aggressive cyclical bear market, but we don’t think this is a killer of the secular bull (as shown below).

S&P 500 bear markets since 1945 (secular bull trends bolded)

Peak Date Trough Date % Decline Days: Peak to Trough Days: 20% Loss to Trough Date of New All-Time High Days: Trough to Recovery Days: Peak to Recovery

05/29/46

10/09/46

-26.6%

133

30

09/15/50

1437

1570

06/15/48

06/13/49

-20.6%

363

0

01/09/50

210

573

08/02/56

10/22/57

-21.6%

446

1

09/24/58

337

783

12/12/61

06/26/62

-28.0%

196

29

09/03/63

434

630

02/09/66

10/07/66

-22.2%

240

39

05/04/67

209

449

11/29/68

05/26/70

-36.1%

543

117

03/06/72

650

1193

01/11/73

10/03/74

-48.2%

630

310

07/17/80

2114

2744

11/28/80

08/12/82

-27.1%

622

171

11/03/82

83

705

08/25/87

12/04/87

-33.5%

101

46

07/26/89

600

701

07/16/90

10/11/90

-19.9%

87

0

02/13/91

125

212

03/24/00

10/09/02

-49.1%

929

576

05/30/07

1694

2623

10/09/07

03/09/09

-56.8%

517

243

03/28/13

1480

1997

Average: Secular Bull vs. Secular Bear % Decline Days: Peak to Trough Days: 20% Loss to Trough Days: Trough to Recovery Days: Peak to Recovery

Secular Bull

-24.3%

239

19

319

558

Secular Bear

-40.7%

562

241

1243

1805

S&P 500 recovers much faster, on average, when bear markets occur within secular bulls

Source: BMO Investment Strategy Group, FactSet, April 2020.

Market forecasts and analyst estimates have been way too bearish and results are now beginning to exceed expectations (under promise/over deliver = secular trend). Yes, growth is down – but this is a given since the economy effectively shut its doors. Now, it is about re-opening, and getting back to work. Our base case scenario is that the S&P 500 Index may reach 3,400 by the end of Q1 next year, while the TSX could hit 18,200 during the same time frame. Why? Because U.S. and Canadian companies are among the best positioned in the world from a fundamental perspective. The recovery, when it is bound to occur, will likely come with a vengeance, as investors turn to high-quality companies for growth, with a primary focus on operating performance, stability of earnings, innovation, and top-calibre management. This aligns with our strategy at BMO U.S. Equity Plus Fund, which has always been informed by comprehensive research, and good old-fashioned fundamental analysis that has led to top percentile returns.1

U.S. and Canadian companies are among the best positioned in the world from a fundamental perspective. The recovery, when it is bound to occur, will come with a vengeance.

The U.S. – A home for stability and consistency

In the U.S., we were overweight in the communication services and technology sectors heading into the pandemic, and that has not changed given that the strength of the economy remains the consumer.  In light of this, we’re also bullish on consumer discretionary stocks as our research shows that the sector has historically exhibited its best relative performance during recessions like 2008; our thematic approach is key here, as we direct our focus within the sector on lifestyle brands. A representation of this theme in our portfolio is Lululemon, which we believe is the next Levi’s, especially as casual wear and “work from home” attire become an increasingly popular trend. REITs are another overweight sector in our portfolio as a source for yield, and as lower interest rates provide support. Overall, we still favour the U.S. over the next 3-5 years, and believe the economy is ideally positioned for onshoring and repatriation, and that overwhelmingly negative sentiment on U.S. politics is clouding investor judgement.

Preparing for the recovery: U.S. sector analysis

Sector Opinion % Weight Theme

Communication Services

OW

12.5%

The three C’s = content, cash and cannibalism; wireless and communications are necessities

Consumer Discretionary

OW

10.5%

Online shopping is safe and so too is casual wear as we work at home

Consumer Staples

UW

6%

Discretionary retail

Energy

MW

3%

Focus on yield and cash flow only; languishing underlying commodity likely to persist

Financials

MW

11.5%

Multi-divisional; biggest of the big are best positioned

Health Care

MW

14%

Biotech, pharma, medical devices are more important than ever

Industrials

MW

8.5%

Will benefit from a cyclical recovery, but stick with high quality

Information Technology

OW

24%

Consumer-driven cash flow and innovators; wireless and broadband budgets to explode

Materials

MW

2.5%

Stay diversified; rebound for metals is coming, but focus on quality

Real Estate

OW

4%

Yield and cash flow; lower for longer interest rates to provide support

Utilities

MW

3.5%

Yield and stability of dividend; lower for longer interest rates to provide support

Source: BMO Investment Strategy Group, FactSet, April 2020.

Canada: A misunderstood value proposition

Meanwhile, we view the Canadian market as misunderstood, and undervalued. Despite the negative rhetoric on Canadian banks and oil shock, TSX performance has been in lockstep with the U.S. benchmark in 2020, and we continue to believe in the strength and stability of companies that have a robust cross-border relationship with the U.S., whose primary or incremental growth is coming from – or geared to – south of the border. On the sector front, we are overweight on communication services, energy, financials and REITs. Within our BMO U.S. Equity Plus Fund portfolio, we have maintained core positions in BMO and RBC, thanks to their more U.S.-centric business and diversified business models, with recent earnings results proving our thesis. Any rally in the next 6-12 months will likely be driven by the Big Six banks, which have consistently demonstrated strong historical dividends (despite contrary market noise). In energy, our preferred stocks employ concentrated and high-tracking error positioning to pipes and integrated oil (yield and cash flow). While we do believe Canada will have its day in the sun when commodities will lead, over the medium term, we still expect the market to embody “As America goes, so goes Canada.”

Despite the negative rhetoric on Canadian banks and oil shock, TSX performance has been in lockstep with the U.S. benchmark in 2020.

It too shall pass so…stay invested

Ultimately, it’s vital to remember that quality stocks drive markets – not simply liquidity. While a cyclical rebound will likely be powerful, Advisors should consider increasing portfolio exposure to fundamental stock pickers – managers that can maintain their positive stance based on quality measures such as operating performance, payout ratios and earnings stability, and who have consistently outperformed the benchmark.

The irrational and fear-laden nature of the current market is a repetition of the 2008 Financial Crisis: how did that turn out? Investors were so consumed with emotion that many of them missed a 10-year run in stock prices. We believe we are setting up for the same heavily fear-laden move to the upside again, and as such, Advisors (if you’re not already) should be prepping their clients’ diversified portfolios for the recovery ahead. 

Disclosures

1 Morningstar Direct, as of April 30, 2020.

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