Belski: Believing in U.S. Equities, Big and Small
Building on the optimism of U.S. markets, Brian Belski introduces the new BMO U.S. All Cap Equity Fund, launched by BMO Investments Inc.
June 2021
Key Takeaways
- New fund invests in U.S. large, mid and small cap stocks
- U.S. companies will continue to lead global growth
- Strong earnings to overcome inflation fears in near term
BMO Global Asset Management has a new fund launching in June – the BMO U.S. All Cap Equity Fund. How does this mandate differ from the BMO U.S. Equity Plus Fund?
BB: The new BMO U.S. All Cap Equity Fund is an opportunity for us, strategists at BMO Capital Markets, to employ our theme of investing in U.S. stocks across the majority of market cap perspectives – including large, mid and small cap stocks. We believe this strategy is supported over the next three to five years, and especially over the next 12 to 18 months. There are no Canadian names in the fund, and we’re benchmarking to the S&P 1500 Index, which is a combination of the S&P 600 Small Cap Index, the S&P 400 Mid Cap and the S&P 500. Because the latter is very similar to the large cap perspective, we can alter sector weights or use the small cap exposure to increase our beta, and that’s really the aim of this new mandate.
How will the U.S. fare coming out of the pandemic?
BB: We continue to believe that the United States will set the pace for the next three to five years. I would also say this: we believe U.S. companies are exquisitely positioned for the medium term. They’re the best managed companies in the world with respect to cash flow and balance sheet strength, and we’ve seen earnings results far exceed expectations this year. The first quarter was a historic period for positive revisions; more than 87% of the S&P 500 surpassed consensus EPS forecasts. As a result, we’ve raised our S&P EPS target for the full year by 8.5% to US$190 from US$175 – which may still be too low. Bottom line: we're starting to transition into an earnings-driven market, which broadens the rally and benefits an all-cap strategy where you can diversify across market cap spectrums.
We’re seeing tremendous optimism around earnings results this year. There have been lots of positive surprises, but investors also have concerns about inflation overheating. How do you reconcile these competing forces in the market?
BB: Well, this notion of inflation fear has really been around for 40 years. Investors have been waiting for it ever since President Reagan, Fed Chairman Paul Volcker and Speaker of the House Leader Tip O'Neill squashed inflation in 1982. Besides, too many people have forgotten what the Fed did in August 2020, when they changed their mandate away from inflation and toward employment. The idea of getting to sub 4% employment in the United States could take several more years to come to fruition, especially given the increased efficiencies in technology and the threat of a national minimum wage. All these factors could obviously put pressure on unemployment.
With respect to earnings, companies have been able to pass along some of the transitory costs that have increased on the input side. Add to this, analysts have been trained to be defensive and, as a result, their numbers are too low. We saw +50% year-over-year growth in the first quarter, so we’re optimistic that second and third quarter earnings will be very strong.
You wrote in late April that investors were feeling anxious about the Biden Administration’s plan to raise corporate tax rates. Can you tell us what specifically you’re hearing in client conversations, and why those fears may be overblown?
BB: On the corporate tax side, yes, fears may be overblown. We’re looking at an imminent move to either 28 or 25%, which would imply an earnings hit of 6 or 3%, respectively. From a longer-term perspective, this is de minimis, which is to say minimal. As I mentioned earlier, we’re dealing with an earnings base that continues to be robust. The bigger question is: what’s happening on capital gains? Investors tend to focus on corporate taxes because there’s little data on how the market has reacted historically. But worrying about taxes is like worrying about inflation, or the second coming of the Great Depression.
The best example is the political environment. Last year we were inundated with questions from investors about the implications of a Democrat in the White House and a blue wave in Congress. We told them the impact should be minimal in the near term. And revenues and profits continue to be strong. Perhaps there’s a cap on market moves at 25 to 30% – but that’s okay. We believe that an environment that offers 10-20% upside in the stock market is still a relatively strong backdrop for equities.
Brian, we like to end by asking for a book recommendation for our Advisor audience. Last time you gave The Art of Contrary Thinking. What do you have for us now?
BB: I would suggest Founding Brothers by Joseph Ellis. It talks about America’s beginnings, the relationships between those flawed, brilliant men and how they were able to work together despite their differences. People know some of this backstory from the musical Hamilton, but the details are what I find fascinating. Why did Burr and Hamilton have to duel in New Jersey, and not New York? Historical reading is deeply ingrained in my investing philosophy, because whatever happened before often portends what could happen in the future. As the old maxim says – all that’s old will be new again.
Read Brian’s latest Market Outlook, or access his U.S. and Canada Strategy Snapshots, by contacting your Regional BMO Global Asset Management Representative.
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