The stock market rally since March is feeding concerns about the disconnect between stocks and the grim underlying economy – but it’s also drawing attention to some of the relatively ignored corners of the market.
While technology superstars and online retailers are exploring record highs in a continuing bet that the COVID-19 pandemic will disrupt work and consumer habits indefinitely, financials, energy producers and real estate companies are mired in deep corrections that, to some observers, look like attractive bargains.
Bill Gross, the billionaire independent investor who co-founded Pacific Investment Management Co., argued this week that value stocks (which are cheap relative to underlying fundamentals such as profits and sales) should outperform the likes of Apple Inc. and Amazon.com Inc. if the recent decline in real interest rates starts to bottom out.
“Value stocks, versus growth stocks, should be an investor’s preference in the near-term future,” Mr. Gross said in his investment outlook.
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Admittedly, value stocks have been underperforming growth stocks for many years, no doubt demoralizing many bargain-hunters. However, a number of unloved stocks look especially cheap right now and they should appeal to anyone wondering why the S&P 500 is essentially flat this year amid surging unemployment, record-breaking U.S. COVID-19 infections and tremendous uncertainty over corporate profits.
Canadian stocks look particularly attractive, and not only because the S&P/TSX Composite Index has lagged the S&P 500 by about six percentage points this year.
Doug Porter, chief economist at BMO Nesbitt Burns, argued last week that Canada has several factors working in its favour: Crude oil prices are well off their lows, declining COVID-19 infections support a more open economy in the second half of the year at a time when U.S. infections are surging, and Ottawa is prepared to offer further support for the recovery.
“The main point is that the relative outlook has started to tilt in Canada’s way,” Mr. Porter said in a note.
Yet Canadian financial stocks are down 16 per cent this year, energy stocks have fallen 47 per cent, real estate investment trusts have declined 21 per cent and even defensive telecom providers are off 9 per cent (all based on sector performance since the start of 2020).
These lagging sectors look like good areas to find stocks that should perform well if the economic recovery continues, yet share prices are reflecting gloom ahead. Here are a few shopping ideas, for a variety of risk appetites.
1. Bank of Montreal
Canada’s biggest banks tend to reward investors who bet on laggards, and BMO’s 25 per cent decline year-to-date puts the stock at the bottom of the pack – well behind Royal Bank of Canada’s relatively mild 6.8-per-cent retreat and trailing the S&P/TSX Composite Index by 15 percentage points.
Why bet on a losing stock? Lagging Canadian banks tend to close the gap with their peers relatively quickly, rewarding investors who take chances on out-of-favour names. Since 2000, following a strategy of buying the previous year’s worst-performing bank stock and holding it for the current year delivered an average annual gain of 15 per cent (not including dividends), beating the bank sector and the broader index.
We won’t know whether BMO will remain the year’s worst performer through the end of 2020, but it is certainly a leading candidate right now. Analysts believe the poor performance is partly because of BMO’s riskier loan book and lower reserves, which makes the stock an ideal holding if lending conditions improve. As you await a BMO rally, you’ll be collecting a dividend that currently yields 5.6 per cent.
2. RioCan REIT
Yes, REITs are having some trouble in getting their tenants to pay rent, and RioCan is no exception. The owner of 222 retail and mixed-use properties reported in its first-quarter financial results that 45 per cent of April rent had not been collected. No wonder the REIT’s unit price is down 44 per cent this year, sending the dividend yield to an eyebrow-raising 9.5 per cent. In June, Canaccord Genuity turfed RioCan from its Canadian Focused Equity Portfolio, which contains its favourite stocks.
Clearly, retail-exposed REITs are tremendously unpopular now, with unit prices reflecting the overwhelming view that consumers are in the midst of a permanent shift to online shopping. But that makes the upside enticing. Johann Rodrigues, an analyst at Raymond James, noted that RioCan has the balance sheet and liquidity to withstand lost rent and bankrupt tenants for the remainder of the year. He expects that any improvement in the retail landscape could make this one of the best buying opportunities among Canadian REITs.
Too dangerous? Then wait for RioCan to report its second-quarter financial results on July 29, which should provide greater clarity on the health of its tenants.
3. Enbridge Inc.
It’s tempting to avoid any stock associated with the North American energy sector, given the volatility in crude oil prices and stiff environmental opposition to expansion. But consider this: West Texas Intermediate crude futures (or WTI, a U.S. benchmark) have been trading above US$40 per barrel since the end of June – after briefly trading in negative territory in April – as demand rises.
Stable oil prices should boost sentiment toward Enbridge – a diversified pipeline operator (full disclosure: I own this stock) whose share price is down 19 per cent this year – and restore confidence in the company’s dividend, which is currently yielding 7.8 per cent.
The bullish bet: Enbridge’s Line 3 Replacement Project to move oil from Alberta to the U.S. Midwest will receive final regulatory approval by the end of the year, and oil producers will ramp up capital spending to take advantage of higher oil prices. Some Canadian energy companies are already restoring production that had been cut earlier in the year. There’s a risk here, for sure, but Enbridge’s share price is an outlier in a broader market that appears far too giddy about the future.
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David Berman