CIO outlines case for Canadian stocks as investors rotate away from big tech
The run in mega-cap tech stocks that drove the S&P 500 upwards for the past two years may be at an inflection point. While calls have been made regarding their price, levels of concentration, or the potential for froth in this market for months now, we have finally begun to see some pullback in the mega-cap technology stocks as investors rotate into more value-oriented names and sectors.
Just as Canadian stocks lagged during the recent tech-driven bull market, a rotation to quality seems to have buoyed the TSX. The wider question then arises for institutional asset managers as to whether we are now in a full-blown market rotation and how an allocation to Canadian stocks can help institutions now.
“When you look at the exposures in Canada, we’re exposed to some of the areas that have lagged and areas that would be the beneficiaries of an early cycle environment,” says Robert Taylor, SVP & Chief Investment Officer at Canoe Financial. “On top of that, if you’re thinking structurally, we may be at the beginning of a commodity bull market as well which would obviously be good for an economy like Canada.”
Taylor sees a rotation in stocks currently underway. He says that this rotation is the product of a US equity market that has become extremely crowded. The top 10 weights in the US are now 37 per cent of the overall market, which he says is the highest concentration we have on record. He says, as well, that some of the exuberance on the market around artificial intelligence has introduced a degree of froth as investors chase themes.
The market has also been concerned about the business cycle. Taylor notes that there have been predictions of slowing inflation and interest rate cuts for some time now, but we’ve only recently begun to see US data that firmly supports cuts by the US Federal Reserve. The US CPI print in July was enough to signal to investors that we are entering an early cycle environment, which prompted a rotation away from tech towards value stocks and sectors.
Given the levels of sector concentration on the market, Taylor notes that almost every sector has lagged technology in recent months, meaning most sectors are poised to outperform in a rotation. That said, he notes early cycle periods tend to favour cyclical stocks like financials, industrials, materials, and housing. Taylor notes, however, that this is not exactly a textbook environment. The impacts of the COVID-19 pandemic are such that almost every sector appears to be in its own cycle.
Given Canada’s relative overweight to those cyclical sectors, Taylor says that there should be some cause for a better outlook on Canada. He notes, however, that plenty of US stocks in more value-oriented sectors will offer similar returns profiles in this environment.
“I think a portfolio of Canadian stocks with some of these cheaper US stocks makes sense in our view,” Taylor says.
Despite his more bullish outlook, Taylor sees risks in the Canadian market. He is concerned that government policy has not supported economic growth and is quite concerned about Canada’s low productivity rates. Private sector growth — which tends to drive innovation and productivity — has been sluggish for some time in Canada.
There is also some concerned that this breadth rotation is short-lived. The end of this run has been predicted before, only for US mega-caps to surge forward again. Taylor, however, says that enough cracks are forming and there are enough signals of extreme market positioning to give him confidence.
As institutions and asset managers look at this landscape, Taylor’s first suggestion is to aim at rebalancing. Rather than wholesale reallocations, asset managers would do well to rebalance to where they see stronger fundamental value. Taylor says that Canada should be an attractive proposition in that environment. He thinks active management will be a key approach.
“I think it’s very stock specific. Our view is that passive strategies are very difficult right now. I think what you want is a good stock picking strategy where the manager has a process that allows them to pick and choose and be off benchmark,” Taylor says. “A strategy where they don’t have to be invested in extended and expensive areas of the market where they don’t see fundamental value. That’s where I would be reallocating to.”
