Canadian equities well positioned for late-cycle environment

Despite inflation’s recent retreat, there is a very real chance it could move higher again next year, says Lisa Conroy, fundamental equity product specialist with Connor, Clark & Lunn Investment Management. And if it does, Canadian equities should do well.

Speaking on the Soundbites podcast, Conroy said the Canadian equity market is well positioned for the current late-cycle environment and offers strong inflation hedges.

“Commodities typically do well in rising-inflation environments. And, as we know, the Canadian equity market has above-average exposure to copper, gold and oil,” she said. “We do expect it to do well as we look forward.”

She said the economy is showing a number of late-cycle characteristics, including:

• economic growth remaining positive but slowing;
• the risk of inflation moving higher;
• increased volatility and uncertainty in the macro-economic outlook and within equity markets; and
• equity valuations moving to very expensive levels.

“All of these examples support a late-cycle backdrop,” Conroy said.

Inflationary factors start with the fact that the U.S. Federal Reserve cut its key interest rate by 50 basis points in an economy that’s growing above 3% per annum.

“In our view, that increases the chance of inflation re-accelerating next year,” she said.

She also suggested that if Donald Trump wins next week’s U.S. election, that could further increase inflation risk, since many of his policies “are inflationary in nature.”

Among his campaign platforms: less immigration leading to labour supply shortages and higher wages, tariffs that could act as a tax on businesses and consumers alike, and increased labour, infrastructure and operating costs for manufacturing businesses as onshoring trends accelerate.

“[As some polls have shown] Trump move ahead of [Kamala] Harris, we have seen inflation expectations move higher,” she said. “And we would expect that to continue.”

Despite the natural volatility of a U.S. election year, Conroy said 2024 has been a surprisingly strong year for Canadian equities.

“Recent accommodative monetary policy — both in the U.S. and in Canada as well as globally — has been a fantastic backdrop for equity markets,” she said. “Canada has seen slower growth than the U.S., but is still enjoying more favourable economic conditions than what many expected.”

In the current moment, Conroy’s looking at the Canadian industrials market as a “catch all” for business models that have exposure to secular themes and can thrive across different market environments. Among the companies she likes are engineering and construction firms Montreal-based WSP Global Inc. and Edmonton-based Stantec Inc. — both of which should benefit from onshoring trends electrification upgrades, she said.

Conroy also likes commodities such as gold and copper for their hedging properties, given that both presidential candidates are likely to increase the U.S. fiscal deficit.

“What we’ve been seeing globally over the past nine months, and what we expect to continue to see, is central banks globally looking to move away from the dollar and into gold as a way to diversify their reserves,” she said. That should be good, Conroy said, for Toronto-based gold producers Agnico Eagle Mines Limited and Kinross Gold Corporation.

Copper will also benefit from secular demand drivers, such as AI, the build-out of data centres, the move to clean energy and electrical vehicle batteries.

Conroy said China’s recent stimulus package may also prove to be a net positive for copper, given that country’s strong demand.

She said financials could do well under Trump, who has communicated a desire for less regulation. A Trump presidency is expected to lead to a steeper yield curve.

“Both of these outcomes would be positive for financials, and in particular, Canadian banks, who have sizable presence in the U.S., companies like BMO [Montreal-based Bank of Montreal] and Royal [Toronto-based Royal Bank of Canada].”

Under a Harris presidency, those companies may not get the same kind of bounce.

“She’s communicated more regulation on financials and technology, as well as higher corporate taxes. So broadly, a slight negative for those banks,” Conroy said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.