Time to watch the early cyclical sectors?

Vaccine-led economic resurgence, ESG focus, and government super-stimulus offer tailwinds in 2021

Time to watch the early cyclical sectors?

For the past few years, the primary premise driving many investors’ portfolio-positioning plans has been the development of a late-stage economy. But following the sharp pandemic-induced recession this year, the focus has shifted to the possibility of a new economic expansion – and four sectors may see the most benefit, according to fresh commentary from AGF Investments.

While the COVID-19 recession has crushed valuations in the credit-sensitive financial sector, the approval and broad distribution of a vaccine should lay the groundwork for the industry to bounce back next year. Richard Fisher, co-head, Equity Research and equity analyst, pointed to several prospective tailwinds such as the return of borrower confidence, a possible release of accumulated loan loss reserves into earnings, and a lifting of restrictions on dividends and share buybacks.

“While re-rating of financial stock valuations could be significant, the governing factor on core earnings growth remains the current zero-bound interest rate policy of central banks,” Fisher said, pointing to banks and consumer finance companies as the seemingly most attractive candidates for investment heading into next year. “[I]n North America, the United States may have an advantage over Canada where a more levered consumer could lead to a more sluggish economic rebound.”

Global commodities, meanwhile, are set to benefit from a cyclical economic upturn. Beyond that, massive government stimulus and the vulnerable U.S. dollar could prove to be catalysts for a new “commodity super cycle,” with selected metals getting an additional boost from new green policy initiatives such as China’s new five-year growth plan and U.S. President-elect Joe Biden’s potential new green stimulus package.

“[C]opper, iron ore and palladium prices have netted double-digit returns year-to-date through November,” said Global Equity Analyst Jamie Maddock, noting that all three metals have outperformed the MSCI All Country World Index. A green energy shift, he said, would prove “exceptionally favourable” for metals including copper, palladium, lithium, and cobalt, many of which are in short supply due to years of under-investment.

The consumer discretionary sector has a history of strong returns following credit- and equity-market recessions, but the uneven impact of government-imposed lockdowns this year suggests that certain sub-industries will perform better than others. Homebuilders have already substantially recovered from the March selloff due to resilient house prices, government limits on foreclosures, and other factors; beaten-down subsectors such as leisure, gaming, and lodging industries carry the potential for a bigger rebound as the wider availability of vaccines allows pent-up demand to be unleashed.

“Still, that doesn’t mean higher returns are a given,” said Credit Analyst Jean-Sébastien Nadeau, who noted that investors might want to consider waiting for a pullback in credit before increasing their exposure to those areas. “Ultimately, liquidity and a relatively healthy balance sheet should remain top of mind for investors seeking the best opportunities among these sectors.”

And even though industrials have bounced back from their lows in March, the sector is positioned for outperformance next year as strong earnings growth combines with potential upward revisions and relatively attractive valuations in certain sub-sectors.

“Global Purchasing Manager Indexes (PMIs) have rebounded strongly and commodities like copper point to a strong recovery in economic activity,” said Global Equity Analyst Angela Rhoden. “Within the sector, the most significant opportunities are likely to be within cyclical sub-sectors, such as machinery, that are trading at a discount to the market yet offer relatively strong earnings growth.”

While fresh lockdowns present a near-term challenge to the pace of economic recovery, Rhoden said the growing prospects of vaccine approval could bolster investor confidence and help market look beyond transitory halts in a recovery.


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