Portfolio managers point to potential in small-cap stocks, still-growing tech companies and dividend-based strategies.
No financial professional predicted the wild ride that was 2020. At least, I haven’t seen anything from last January that spoke presciently of a pandemic that would shut down the global economy and sink markets by more than 35% over a four-week span, only to have stocks end the year off in the black. (The S&P/TSX Composite Index climbed by 2%, while the S&P 500 was up 16%.)
So, while it’s impossible to predict what might happen in 2021, we’re still going to give it a try. Over the last few weeks, I asked four Canadian investment professionals for their thoughts on the year ahead.
Chris Heakes, vice-president and portfolio manager, Global Structured Investments at BMO Asset Management
We are cautiously optimistic for 2021. With vaccines rolling out, and fiscal and monetary stimulus continuing to be in place in developed markets, we think there is the possibility of 2021 being much better from an economic and recovery point of view. Overall, we’d continue to advocate for high-quality equities as higher-quality companies are better suited to navigating a challenging backdrop. We do still expect some lingering volatility but, again we’re optimistic on a 12-month lookout that business activity should pick up, which will lessen credit risks and potentially allow some beaten-up areas of the market to recover further. As a base case, we would look for high-single-digit- to low-double-digit equity returns in this scenario.
As for sectors, I’d look to financials, in particular banks—both north and south of the border. I also like dividend-based strategies, which underperformed in 2020, while tech took the centre stage. I think this could reverse and investors could look at high quality dividend-based strategies. Lastly, I like industrials and real estate investment trusts as well. Certainly there are some challenging times to navigate, but with progress being made around COVID-19, these sectors are attractive over the next 12 to 24 months.
David Barr, president, CEO and portfolio manager at PenderFund Capital Management
For the first time in a long time, we are seeing more retail investors participating in the continued upside in small caps. However, whenever a long-term trend reverses, we have to wonder if it can be sustained. Market history tells us that usually these swings don’t just last for one or two quarters. We believe there are many small-cap companies still on their path to recovery and that with the renewed optimism of a vaccine, we are on the verge of seeing strong earnings momentum for these businesses.
We have been talking a lot internally about a group of companies we call the “ZIPSS”—technology companies that have some similarities to the business models of the popular, high-flying big five tech names like Amazon and Facebook, but which we believe have much longer runways of growth ahead. With the digital transformation we are witnessing, further accelerated by the global pandemic, we believe these companies are poised to create a lot of value for patient shareholders in the years ahead.
The pack is represented by a group of five companies that are amongst the disruptive breakout leaders in their industry. Zillow Group Inc. is disrupting how property is bought and sold; IAC/InterActiveCorp is poised to transform a whole host of services from search and entertainment to finding work and home repair; PAR Technology Corporation is gaining momentum and benefitting from the massive tailwinds caused by the sudden need to re-platform and digitize the restaurant industry; Stitch Fix, Inc. is an online apparel company focused on hyper personalizing proper fit and style of clothing in order to delight consumers; and Square, Inc. is a leading fintech that has become a significant disruptor in the payments and banking industry. These companies have promising economic models to drive profitable growth as they scale; they are amongst the breakout leaders in their respective categories that benefit from positive feedback loops, which tend to make the strong even stronger; and they target industries with massive total addressable markets.
Rob Edel, chief investment officer, Nicola Wealth
The underlying issues that have been driving the market are monetary and fiscal policy, and that will continue to be the catalyst in 2021. There is some concern that [bullish] sentiment gets overdone and that you have a pullback at some point, but I think the market would welcome that. As long as interest rates stay low and we don’t have fiscal tightening—and with a democratic administration in the U.S. having enough power to spend money, but not enough to raise taxes—that’s a positive for markets. At the same time, central banks have indicated that they are going to keep monetary policy easy for an extended period of time.
The key variable to watch is the bond market, and especially 10-year yields. If the economy recovers and if you see inflation [rise], where will the 10-year yield go? At what point does that become a problem for the market? The issue is that if yields rise, the discount valuation process becomes more problematic. One reason why people are OK with present equity valuations (which are reaching record highs) is because of low rates. If you’re using a higher interest rate when discounting future earnings, you then get a lower valuation. So that’s one thing, but also there’s the opportunity cost: If yields go up, it makes fixed income more attractive.
We still have a pro-cyclical view of the market. The global economy will be recovering, and while we do think rates will rise that can also be a sign of a healthy economy. It’s only after a certain level that it becomes problematic. There are opportunities in industrials, materials, some consumer discretionary stocks. The hard part is that you have winners and losers from the pandemic, so you need to pick stocks. In part there are buys in beaten down stocks, but you have to be careful. I wouldn’t be looking at a department store, but I would look at Aritzia (a Vancouver-based, women’s-focused fashion company). The clothing market has been challenged, but if you believe people will spend money on clothes again, then they’ll benefit because they’ve been able to invest in e-commerce and they still have a good runway for growth.
Paul Harris, partner and portfolio manager, Harris Douglas Asset Management
There are two important things for 2021. One is that rates will remain low throughout the world and that bodes well, generally, for the stock market. We’re not going to see the kinds of rates of return we saw in March, but we could get between 5% and 8%. I also think there’s an overemphasis on how much inflation we’ll see. We might get some higher inflation numbers for two or three months, but we won’t see much beyond that as the output gap is so wide in most parts of the world. [A positive output gap is when there’s too much demand, which can increase prices and therefore inflation.] The world—including Canada, the U.S. and Europe—has taken on an excessive amount of debt, and you can’t grow with that much debt outstanding. The average growth is going to be around 2% for a long time. If you don’t have high growth rates or high inflation, then the stock market can do reasonably well.
A lot of themes that played out in the pandemic will continue to do well, such as cloud video streaming, online retailers and semiconductors. Companies have to digitize more and so there’s a more and more of a push to the cloud. Growth stocks will continue to outperform value. They’re better-run companies, and to get value companies to do really well, we need the economy to be strong and [we need] inflation. You also want to buy growth in a low-growth, low interest rate environment as that’s the only place that’s actually growing earnings. Look at buying good companies with good balance, that also have good growth prospects.