OUTLOOK COMMENTARY APRIL 2021 - CWBMP.COM - CWB MCLEAN & PARTNERS
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Outlook Commentary April 2021 CWBMP.COM OBSESSED WITH YOUR SUCCESS ™
Inside Delayed Take-Off.........................2 Canada.................................. 3-4 U.S......................................... 5-6 International...........................7-8 Fixed Income........................9-10
Delayed Take-Off
Scott Blair, CFA
Chief Investment Officer
One of the most frustrating things about flying is the delays. Strong growth often brings talk of inflation and, of course, that’s a
We’re usually excited to get to our destination, and the last thing realistic fear and is getting a lot of media coverage. Undoubtedly,
we want to hear is that takeoff has been pushed back by a few we’ll see pockets of inflation. Just as we saw shortages of some
hours. This kind of anticipation is analogous to our current goods over the past year because we all demanded the same
situation in Canada. stay-at-home products, we’ll likely see shortages again as our
demands shift to the re-opening products and services.
Vaccines are being distributed, the weather is getting nicer, we’re
excited to get out of the house and back to our regular activities Of course, businesses that were hurt the most from being locked
– but we’re now being told to wait little bit longer! At the time of down will also benefit the most from re-opening, and there should
SVX Index SGX Index
writing this, Ontario is signalling a return to lockdown and BC is be strong demand for workers in these spaces which could lead
170
once again restricting indoor dining. Other jurisdictions, both here to wage inflation. Although we don’t see runaway inflation anytime
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and abroad, are again looking to tighten up amid rising COVID-19 soon, we do think it will rise to more normal levels and could
150
variant cases. overshoot to the high side.
140
130
Although disappointing, we view this as a detour on the return to The past twelve months have been fantastic for major stock
120
normal road – not something that’s taking us off course. markets - many of which are up 40 or 50%. Though it’s highly
110
100
unlikely that we’ll see 50% returns in the next twelve months, we
90
“We now have a template for what are positive
more
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return to normal looks like, and that 03 04 0 0 0 0
Over the past year, growth (stay-at-home techSource:
names)
0
performed
02 0
”
Bloomberg
is Israel. well early in the pandemic. The spread between the S&P Growth
and Value indices peaked in August, and began to narrow in
November once the vaccines became a reality. The spread has
Well over half of the population of Israel is vaccinated. Once
continued to narrow in Value’s (more economically sensitive stocks)
vaccination levels neared 40%, Israel saw a lasting drop in cases.
favour ever since (Figure 1).
That doesn’t mean the virus is gone today, but the waves and
surges have stopped. Figure 1: Growth of $100 – S&P Value vs. S&P Growth
During the recent Passover holiday, Israelis were permitted to gather S&P Value S&P Growth
in groups of 20 indoors and 50 outside. The UK is the only other 170
major country with over 40% of the population to have received at 160
least one dose of the COVID-19 vaccine. They too relaxed restrictions 150
recently with groups of six allowed to meet outside, sports facilities 140
reopening and the stay-at-home rule ending. 130
120
The U.S. should come close to a 40% vaccination rate in April. Most 110
other developed nations have 10-15% of their population vaccinated 100
(including Canada). For these countries, June is a reasonable goal for 90
meaningful relief of restrictions. However, by increasing lockdowns 0 20 0 0 20 21 02
1
202 20 202 202 20 20 2
ar ay ul pt ov an ar
now and targeting the most vulnerable populations for vaccinations, M M J
Se N J M
we could see significantly better days in May. Source: Bloomberg
So what does all this mean for our economic recovery? We still see
The second quarter of 2021 should be a transition quarter for
very strong economic growth ahead. In fact, we think this year’s
Canada. Hopefully, one that sees easing of many restrictions
growth will likely surprise to the upside. There’s enormous pent up
as we move towards the summer. Think of it like the plane on
demand, low interest rates and extremely high savings levels. It’s a
the tarmac, starting to move slowly forward at first before
powerful combination, with reopening being the catalyst to unleash
accelerating into takeoff.
the growth. We’re already seeing businesses anticipate the recovery,
with Canada’s major airlines announcing a more normal summer
schedule for instance.
2
Canada
WATCHING
The first quarter brought about a level of mergers and acquisitions Edward Friedman, CFA, MBA
(M&A) activity that we have not seen in years. Among the activity Portfolio Manager
announced were five major proposed deals that involve companies
we hold in our portfolio.
THINKING
What led to such a flurry of mergers? We believe that a confluence A summary of the announced mergers follows:
of several developments led to this:
Alimentation Couche-Tard (ATD) and Carrefour
ATD agreed to acquire Carrefour for US$20 billion. The stock
dropped 10% on the day of the announcement since this merger
was to be fully financed with debt, and this would be the first time
ow interest rates: All the deals involved significant
1. L
that ATD acquired a grocery business – which is an entirely new
amounts of debt or debt recycling.
segment for the company. The deal was met with strong opposition
2. Post-COVID reality: The economic crisis led
from the French government due to concerns about food supply
companies to focus on their core operations, or join
and employment. ATD consequently abandoned the merger talks.
forces with stronger players in order to adapt.
3. Matching interests: Some of the deals have been Arc Resources and Seven Generations (7Gen)
contemplated for years, however interests of all Arc agreed to acquire 7Gen in an all-share deal under which the
parties eventually aligned. shareholders of each company will own 50% of the combined
company. Production of the merged company will be 340,000
barrel of oil equivalent (BOE)/day, of which 58% is gas, 22%
condensate and 20% oil and natural gas liquids (NGLs). The merger
is expected to generate synergies of $110 million and though the
combined debt will be higher than Arc’s target of 1-1.5x net debt to
Fund from Operations (FFO), Arc is projected to get to the bottom
of that range by the end of 2022.
3 | OUTLOOK COMMENTARY
We liked that the management will focus on free cash flow The market gives the deal only about 60% chance of approval.
generation and, for the first time in years, capital allocation We believe a deal will be done but it is likely that some assets,
will include both dividends and share buybacks. such as Shaw’s Freedom mobile network, may have to be sold
before approval due to competitive reasons.
TFI International and UPS Freight
TFI agreed to buy UPS Freight from UPS for US$800 million, Canadian Pacific Railway (CP) and
financed by debt. The stock was up 32% on the announcement. Kansas City Southern (KSU)
We like this deal for several reasons: CP agreed to buy KSU for US$29 billion in
cash and stock, including assumption of US$3.8
• UPS freight was sold with no debt and no liabilities. UPS will
billion in KSU’s debt. CP will finance the deal with US$8.6 billion in
bear responsibility for all prior pension and accident liabilities.
debt and 44.5 million shares. When concluded, CP’s shareholders
• TFI expects to generate significant synergies by raising UPS will own 75% of the combined company and KSU’s shareholders will
freight margin from 1% to TFI’s level of roughly 12%. own 25%. Leverage will increase to 4x, but management expects
• The acquisition will give TFI access to more markets in the it to be cut to 2.5x in 2023. Management targets US$800 million
U.S. and enhance its scale there. in cost and revenues synergies.
Rogers and Shaw This merger makes a lot of sense. CP has been trying to replicate
Canadian National Railway’s (CN) network access to three oceans
Rogers agreed to acquire Shaw for $26 billion, financed mostly by
for years. This merger will give it this access plus access to the
debt and a small portion with shares. The deal made a lot of sense
growing trade hubs of Mexico.
to us since Shaw will give Rogers broadband and cable operations
in the West, which are operations that Rogers does not currently Regulatory approval is expected by mid-2022, which is why the
have. It also makes sense to Shaw shareholders, as they’re receiving market gives this merger only 60% chance of approval. However,
a premium of 70% on the pre-announcement price, and it will take unlike in the Rogers deal where competition is expected to decline,
off the risk of large capital investment in 5G. Rogers expects to competition here will remain the same since CP and KSU have only
generate $1 billion in synergies over two years and get its leverage one connection point, and the expanded network will give clients
to ~3.5x within three years. more options for single-line freight. Management is also convinced
that the deal will be approved.
The most significant risk to this merger is regulatory approval,
as it’s expected to reduce mobile competition in the West. Rogers
tried to sweeten the deal for regulators by committing to invest $1
billion in rural and Indigenous communities to improve connectivity,
and invest $2.5 billion in expanded 5G network that will create
3,000 jobs.
DOING
Though the ATD-Carrefour merger did not go through, ATD’s shares We strongly support the CP-KSU merger and believe that
dropped over 10%. After reviewing the valuation and judging the management’s synergies are conservative, as the expanded network
chances of deal approval as small, we increased our weight in ATD will allow CP to better compete with CN. CP made a lot of progress
by 30 bps from 1.2% to 1.5% as we viewed the stock as undervalued. in gaining market share over the past few years after it appointed a
Chief Marketing Officer. This deal will help increase CP’s network
TFI’s shares reflected half the benefits management is targeting.
utilization. As such, we increased our weight in CP by 25 bps and
However, like with other acquisitions, there is a significant risk of
reduced CN’s weight by the same. We plan to increase our weight
execution. As such, we reduced our weight from 2.2% to 1.8%,
further as opportunities arise.
taking advantage of the 32% share price increase.
4
U.S.
WATCHING
The U.S. economy outperformed most developed markets in
Liliana Tzvetkova, CFA
Q1 thanks to aggressive vaccination campaigns and additional
Portfolio Manager
fiscal support. The U.S. is ahead of most countries on the
vaccination front and its fiscal policy has been more generous
than elsewhere. Many states saw some form of easing in
lockdown measures, and the $1.9 billion relief package
signed into law on March 11 has already resulted in an uptick
in consumer spending and confidence. Retail, dining, and
hospitality businesses that have recently reopened saw Saket Mundra, CFA, MBA
significant increas in demand with restaurant occupancy Portfolio Manager
getting closer to pre-pandemic levels.
Turning to the equity markets, the rally continued into 2021 with
the S&P 500 up 5.8% (4.4% in CAD) in Q1. The rally that started
a bit over a year ago has been extraordinary, and while stock All sectors finished in positive territory in Q1. Leading sectors
participation was initially more focused in certain stocks and were Energy, Financials, and Industrials – value sectors that
sectors (FANGs, Technology), we are now witnessing much underperformed for most of past year. The worst sectors were
broader equity participation. The rotation from defensives to Defensives (Consumer Staples, Utilities and Health Care)
cyclicals and from growth to value started last November, and and Technology. We saw a large increase in the U.S. 10-year
continued throughout the first quarter. For the first time since government bond yields, and Energy and Commodities
2016, we’ve seen a long stretch of value outperforming growth ex-Gold rallied.
(to clarify, we’re only talking about six months).
5 | OUTLOOK COMMENTARY
THINKING
We continue to expect a robust economic recovery throughout the While we anticipate a strong 2021, there are always reasons for
year, barring any hiccups due to variant strains of COVID-19 or other caution. We expect an inflation uptick in the near term due to
external shocks. The Q4 earnings season was strong with earnings strong pent-up demand, especially in certain areas such as services.
and sales both increasing 4% year over year (significantly higher Although our current expectation is that this will likely prove to
than what was expected) with a large share of companies beating be transient rather than a structural change, it might still have a
expectations. short-term negative impact on equity markets.
Furthermore, comments from management teams were largely
positive and supportive of strong growth. The market is expecting
earnings per share (EPS) to grow 24% in 2021 and 15% in 2022.
“On the vaccine front, if there’s
This bodes well for U.S. Equities and we expect stocks to do well, anything we learned last year, it’s to
especially if the Fed stays put and does not increase interest rates,
which is what they have telegraphed.
not underestimate the virus. If more
The rotation from defensives to cyclicals is not surprising considering variants emerge and vaccines are
these sectors will benefit the most as expansion advances. These less effective, growth might be less
sectors also lagged last year, and for some, even longer.
We expect this rotation to continue with valuations remaining
robust than forecasted. ”
attractive. If the economic recovery proves to be stronger than
anticipated, it will likely mean stronger earnings than expected
for value/cyclical stocks which is positive for share prices. With a
significant increase in long-term government yields, the yield curve
has steepened, which is bullish for banks earnings and returns.
DOING
The portfolio continues its gain against the benchmark as the We added to names such as Microsoft, Alphabet, Dollar General,
rotation into value stocks strengthened. We also benefitted Union Pacific, J.P. Morgan, Wells Fargo, Deere, CMC Materials,
significantly as our thesis on a number of our holdings with TJX and a few others.
idiosyncratic drivers came to fruition. We exited these idiosyncratic
While different factors may work during different periods,
positions, such as GameStop, Coherent, and American Woodmark,
we continue to follow our investment process by buying
as the price reached our estimate of fair value. Staying true to our
fundamentally strong businesses at lucrative prices and owning
process, we redeployed capital in a number of names where we
them over long periods. We believe this will lead to superior
found the risk/reward to be conducive.
returns for the portfolio.
6International
55
50
WATCHING 45
European Cyclicals vs Defensives
Monetary policy continues to impact40 market dynamics as it has
Ric Palombi, CFA
over the past year and decade. Interest
35 rates continue to hover
% From 1Y Low
Director of Research
around historically low levels. As global
30 economies continue to
recover from the COVID-19-induced 25 recession, central bank
monetary policies will continue to20 play a key role in the evolution
of the overall and intra-market performance.
15
One of the biggest debates in the 10market right now relates to
the relative outperformance of cyclical
5
their defensive counterparts. Cyclical
stocks compared to
0 companies in Europe have
“The unavailability of chips costing
outperformed defensive businesses 70 by72over
74 7650%, from
78 80 82 84 86the lows
88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 just tens of dollars each has held
in 2020 (Figure 2). This has handily outpaced the best relative Source: MSCI, Morgan Stanley Research back the production of millions of
performance for the cyclical group in most of recent history, which
raises questions around the durability and sustainability of the rally. vehicles costing tens of thousands
Another topic that’s been prominent in the news is semiconductor
shortages. Many different industries have been affected, with the
of dollars each. ”
most prominent being the Auto industry.
Figure 2: European Cyclicals Outperforming Defensives
55
50
European Cyclicals vs Defensives
45
40
% From 1Y Low
35
30
25
20
15
10
5
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20
Source: MSCI, Morgan Stanley Research
7 | OUTLOOK COMMENTARYTHINKING
The yield curve has steepened significantly in recent months as To deal with the shortage of semiconductor manufacturing
longer-term yields have risen, while short-term yields have remained capacity, the market leader in the fabrication industry, Taiwan
low. Despite the steepening, yields are still below prior peaks. Semiconductor Manufacturing Company (TSMC), announced a
However, we believe there’s a real risk that yields will spike above massive US$28 billion capital expenditure plan. The scale surprised
previous levels as central banks have indicated a willingness to let all industry observers. Similarly, Intel announced an upsizing of
inflation run hot as the economy heals. A steepening yield curve its capital expenditure for 2021 from $14 billion to $20 billion.
should be beneficial for cyclical companies and Europe, which is a The global shortage coupled with the dependency on just a
pro-cyclical market (Figure 3). handful of Asian manufacturers for critical semiconductors has
also led to a push by U.S. and European governments to develop
Figure 3: Europe’s relative performance has tended to correlate
with U.S. real yields local manufacturing capacity.
US 10Y Real Yields (%) MSCI Europe vs ACWI (RHS) Many more billions will be spent over the coming decade to build
up global capacity. The R&D budgets in the industry are also
1.0 105
impressive: TSMC will spend over $4 billion on R&D in 2021 alone.
0.8
Of course, TSMC, Intel, or Samsung would not be spending these
0.6
100 billions if they did not believe they could make attractive returns on
0.4 these projects. The strong end-market demand for semiconductors,
0.2 along with the demand for leading edge technology, has led to a
95
0.0 gold rush in the industry. And as the expression goes: it often pays
-0.2 to be a shovel maker in a gold rush.
90
-0.4
-0.6
-0.8 85
-1.0 DOING
-1.2 80
Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 As mentioned earlier, a steepening yield curve environment should
Source: MSCI, Refinitiv, Morgan Stanley Research
be beneficial for the financial sector, while an improving economic
outlook should continue to provide an earnings recovery and boost
In our view, an improving macro outlook and a higher inflationary for cyclical companies. The portfolio continues to maintain healthy
regime should provide a material earnings boost for cyclical exposure to these themes, while at the same time we’ve trimmed
names, where earnings projections have not recovered to some of our heaviest cyclical names such as Sony, Prada, Maersk
pre-pandemic levels. and Antofagasta to reflect their changing risk/reward profile
following their stock price rallies.
Figure 4: European value stocks earnings estimates are 17% below
pre-pandemic levels Our portfolio has a healthy exposure
to the sole shovel maker in the semis
500
industry: ASML. ASML makes the
450
$200 million bus-sized machines that
400
use lasers to etch out the incredibly tiny transistors and circuits on
350
each chip. Many years ago, our analysis had shown that ASML’s
300
technological edge was so strong that it would eventually be the
250
only vendor for lithography equipment. That has come to pass.
200
With 100% market share and an incredibly strong forecast for
150
spending by customers, ASML is well placed to continue its strong
100
earnings growth profile over the coming decade. Thus, while the
50
shares appear somewhat expensive when viewed in the near-term,
0
the strong earnings growth means that the shares will continue to
Apr-11
Jun-15
Apr-16
Feb-17
Jun-10
Feb-12
Oct-13
Dec-17
Oct-18
Dec-12
Jun-05
Aug-14
Aug-19
Jun-20
Apr-06
Feb-07
Oct-03
Dec-07
Oct-08
Dec-02
Aug-04
Aug-09
compound upwards in value over time.
Source: MSCI, IBES, Factset, Bernstein analysis
The earnings are backed out from the 12-month forward pe ratio and the performance index of the
cheap quintile of stocks from our US Composite value basket. We define composite value as
screening on an equal weighted blend of Price to book, 12-month forward pe and Dividend Yield.
8Fixed Income
WATCHING
Simply stated, too many market participants still think the Fed’s
reaction function is like it was pre 2020. It really isn’t. The move by Ric Palombi, CFA
the Fed to adopt an Average Inflation Target has changed the game. Director of Research
Consider the following from the Fed’s last meeting: Real GDP
projections were revised up for 2021 and 2022; its inflation target
for 2021/2022/2023 is now at or above 2%; and the unemployment
for 2023, which means the Fed does not forecast raising interests
rate for 2022 is now at 3.9% (below the long-run equilibrium rate
rates in 2023. So, as our colleague, Edward Friedman, likes to say,
of 4%).
“What gives?”
The conventional response to stronger-than-expected growth,
Fed policy makers have doubled and even tripled down on their
coupled with steep declines in headline unemployment, would have
stridently dovish stance. They indicated that a rise in core inflation
steered monetary policy towards tightening (such as increasing
above 2% in 2023 is not grounds alone for a rate hike because
rates) in anticipation of higher inflation. In fact, the bond market is
maximum unemployment is a key goal. Chairman Powell was
pricing in a 25 bps rate hike at the start of 2023, and two more hikes
adamant that the Fed will react to data and not forecasts when it
of that size by the end of 2023. The thesis is that trillions of dollars
comes to inflation, and will specify what “overshoot” means once
in stimulus coupled with an accelerating vaccination campaign
inflation is above 2%.
means front-end rates cannot stay this low without inflation spiraling
out of control. Yet, there’s still no change in the Fed’s expectations So, we think the playbook for the Fed looks something like this:
1 2 3 4 5 6 7
Wait Signal for taper Taper Wait for inflation Specify what Wait for overshoot Start hiking
for data (the slowing of securities to move above 2% an inflation criteria to be met
purchases that support (on a sustained basis) overshoot means
the economy)
(what level or conditions
concern the Fed)
9 | OUTLOOK COMMENTARYTHINKING Recessions US 10-2 year Yield spread Average
In our estimation, the implications for
250investors are enormous. We are firmly in the former camp.
First, the yield curve has definitely steepened but the curve is
200 While the probability of this scenario playing out is high, the risk
no where near historical levels of steepness (Figure 5). Given the
150 is that the Fed will put on the brakes too quickly and cut the
Fed’s new policies, we believe the steepening should at least be
100 economic cycle short. This would take the form of premature or
at prior peak levels, but may continue well beyond. This implies a
more aggressive tapering of asset purchases and/or increases in
normalization of interest rates higher50than what is currently being
the Fed Funds Rate more quickly than the market anticipates.
discounted by the market. 0
Even in this scenario, however, our thesis does not break. It just
-50
As we stated, the conventional policy response
85 88 91 reflected
94 97in the
00 03 06 plays
09 out
12 much
15 more
18 21quickly as the economic cycle burns hotter,
bond market stands in stark contrast to the Fed’s unequivocal but shorter, than anticipated.
Source: Bloomberg Finance L.P.
message. Will the market move towards the Fed or will the Fed shift
its reaction function towards the market’s conventional thinking?
Figure 5: 10-2 year yield curve and recessions
Recessions US 10-2 year Yield spread Average
250
200
150
100
50
0
-50
85 88 91 94 97 00 03 06 09 12 15 18 21
Source: Bloomberg Finance L.P.
The 10-2 year yield is the difference between the 10 year treasury yield and the 2 year treasury yield.
DOING
Recognizing what’s different in this economic cycle is critical and preferred shares, which directly benefit from interest rate
for how we think about positioning our Diversified Fixed Income normalization. Our exposure to these has generally buffeted the
Pool. As the thesis of reopening economies, reflation and interest rise in interest rates by being much less interest-rate sensitive.
rate normalization continues to play out, we believe the best risk/ They also provide a better income stream than government
reward for fixed income investors continues to be in inflation bonds, and have appreciated in value as corporate bond
hedges. We’ve continued to add to floating rate corporate bonds spreads continue to contract and interest rates normalize.
10CONNECT WITH US CWB McLean & Partners provides clients with financial peace of mind. 1.888.665.0005 | solutions@cwbmp.com. STAY AHEAD OF THE CURVE If you would like to receive our publications directly to your inbox, you can subscribe by visiting cwbmcleanpartners.com/subscribe or by emailing solutions@cwbmp.com. The material and opinions in this report are for informational purposes only and do not constitute a complete description of our investment services or performance. The materials are in no way an offer or solicitation for the purchase or sale of any security or financial instrument. Prior to acting on any information presented you should take into account your own investment profile and if necessary seek professional advice. Information throughout this presentation, whether stock charts, quotes, articles, or any other statement or statements regarding market or other financial information, is obtained from sources which we, and our suppliers, believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this commentary should be interpreted to state or imply that past results are any indication of future performance. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the user. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information shared in this report. CWBMP.COM OBSESSED WITH YOUR SUCCESS ™
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