Belski: It’s a Stock Picker’s Market Offering Selective Opportunities

So far 2023 has resembled something of a Charles Dickens novel. It’s been the best of times one moment and the worst of times another. To modify the title of the famed writer’s masterpiece, the first months of the year have been a Tale of Two Markets.

January was jubilant. Stocks rallied on the belief that central banks had pulled off the improbable. Inflation was falling back towards the target rate without a painful economic reset in our view. Yet except for some spillover exuberance in February, volatility has seized the day once more. Recession risk looms while the sudden failure of Silicon Valley Bank and the cascading ripple effects felt across the broader financial sector have shaken investor confidence.

Trying to time the market in this kind of environment is a fool’s errand. Instead, prudence demands remaining invested and being opportunistic. Should you deploy cash into favoured or core holdings during sell-offs? Yes. Should you sell one position and buy another brand-new one? That’s a more difficult proposition to rationalize.

I’m of the belief that markets are entering an era that resembles what we witnessed in the 1980s and 1990s, where yields on bonds such as 10-year Treasuries will fetch between 3% to 4%, large-cap stocks will sustainably generate single-digit earnings growth while their shares post single-digit to low double-digit annual gains. But before we get there, investors will need to weather near-term volatility as markets and the broader economy absorb higher interest rates.

The chart below illustrates that for those that stay the course and are selective about where they invest, their patience should be rewarded. History shows that significant downturns are almost always followed by sharp, sustained recoveries over time. The chart shows the performance of the S&P 500 in the aftermath of major declines dating back to the Vietnam War. On average, the index has delivered a total return of 333% to investors 10 years after a market crisis—if they remained invested.

SPX Index cumulative total return after crisis (%)

Source: Bloomberg Finance L.P. For more details, please consult The Big Picture, as of December 2022.

I think Canadian stocks can do very well through the near-term volatility, benefitting our BMO U.S. Equity Plus Fund, which allocates 28.9% of our holdings to TSX equities.¹ We still hold a favourable view of Canadian banks, some tech companies, some materials companies and select industrials. I've used the word select intentionally. This is not a market for index investing—where you can simply buy the Nasdaq or the S&P TSX. You want to be diversified but also very selective about individual stocks.

Quality is back in favour. We’re on the hunt for companies that can exhibit consistent earnings growth with improving operating metrics such as return on assets, on invested capital and return on equity. Diversity also means prudent risk management. For every stock you hold that has a multiple that’s higher than the market, you want to match that with a lower-than-the-market multiple stock. For every NVIDIA position, you want to own Qualcomm. For every AMD, you want to own Texas Instruments.

For U.S. stocks, we like very select technology, industrials and some energy. The areas we don't like are consumer staples and utility stocks, which have become very expensive — utilities are the most expensive sectors in the world right now, both in Canada and the United States. Too many investors have chased these traditionally defensive areas.

Internationally, investors need to likewise screen for quality and valuations. Many investors have piled into the China “reopening” trade and emerging markets (EM), which did very well last year. But EM performed well because the dollar was so high. Our view on the greenback is for the globe’s reserve currency to face headwinds in the coming quarters while North American stocks’ reliance on China for growth will continue to diminish. With so many investors focused on the China story, we’re looking elsewhere.

BMO U.S. Equity Plus Fund – Series F US$: Growth of $10,000

Source: Bloomberg, BMO Global Asset Management, as of February 28, 2023. The chart illustrates the impact to an initial investment of $10,000 dollars from Fund inception (April 16, 2015) to February 28, 2023 in the BMO U.S. Equity Plus Fund Series F US$. It is not intended to reflect future returns on investments in the Fund. Series F units are only available to investors who participate in eligible wrap programs or flat fee accounts with their registered dealers that have entered into a Series F Agreement with BMO Investment Inc.

These views shape our near-term approach and investment objectives for both the BMO U.S. Equity Plus Fund and BMO U.S. All Cap Equity Fund. But of course, we are keeping a keen eye on what sectors and names will emerge as market leaders in the coming era I described above.

The themes for the next three to five years are ones of value: growth at a reasonable price, and quality small- to mid-cap stocks over large cap. That doesn't mean you should sell your large-cap stocks, but it means we see opportunities in the small- to mid-cap names we believe could outperform larger cap names over the medium term.

The BMO U.S. All Cap Equity Fund allows us the ability to look longer term. For instance, we own a stock called Sonos, Inc. an innovator in the audio space. We also favour names like Stifel Financial Corp. and Raymond James Financial, Inc. in the U.S. financial services sector, with the brokerage business being a space we believe will do well thematically.

But we believe investors need to position themselves now in order to fully participate in both the broader market recovery after the current volatility has subsided, as well as in the names that will generate strong returns in the next cycle.

For strategies and insights to protect and grow your clients’ holdings, contact your BMO Global Asset Management Regional Sales Representative.

¹ Bloomberg, BMO Global Asset Management, Series F, as of January 30, 2023.