RBC Global Asset Management

Post-election U.S. equity update with Brad Willock

What do you expect to be the drivers of the U.S. stock market going forward?

Well, thank you.

Brad Willock Vice President & Senior Portfolio Manager, U.S. Equities, RBC Global Asset Management Inc.

The long-term drivers of the market, now that we’re through the election. I think there are three major ones. And the first is the path that we take “back to normal”. The vaccine is the principle driver of our path back but we’ve had some data that’s shown that at least the first two vaccines that we’re likely to get have a very high efficacy rate. But what also matters a lot is the distribution of the vaccine and whether people take it. We’ll call that compliance. And it’s those things together, the compliance as well as the efficacy, that will determine when we can get back to “normal”. I think the base case that I’m working with is something like most Americans, or people in North America, should be able to have a vaccine by summer, summertime. Say think about back to school next year as being the time when maybe 60% to 70% of people will be able to take a vaccine. So that won’t be quite normal. I don’t expect normal will be until 2022. But it is coming and the market does sense that. Another part of a major driver would be we’ve had this, obviously, an election, and now it’s not quite complete. It does appear quite clear that President-elect Biden will be the next person in the White House. But a big part of this is what happens with the final two senate races, which are in run-off, and that’ll happen January the 5th. Those are two seats in Georgia. Now the Republicans will be spending a lot of money. The state has always been a Republican state, but they’ve made a pretty big transition here and has become a Swing state. So these two races are key. Currently the senate is 50 Republicans, and 48 Democrats, with the last two seats yet to be determined. I think the base case is probably that the Republicans will win at least one of those two seats, if not both, and retain control. If they don’t, and it comes out 50/50, then, as you know, the Democrats will be in control of the senate because the tie breaker is the Vice President, in this case Kamala Harris. And so the Democrats would then take control. So that’s a small—I think a small odds event, but it is something that I’m considering. And the third thing is the—as far as a driver of the market, and a very major one, is the style shifts that we’re seeing, and there’s quite a few things going on underneath the index. Growth versus value, large versus small cap, even the U.S. market versus the rest of the world. These are some style shifts that are in motion at the moment. These processes started to unwind back in the summertime in some cases, but more recently since the election has changed and we’ve gotten some vaccine data.

What parts of the economy are more favourable under a Biden administration?

Well now that we’re through the election, at least we appear to be, and President-elect Biden will be the next person in the White House, the question is what does a Biden presidency do to our favourite sectors and things that are maybe things we should avoid and some of the changes that have to be made. First, one should think about what the goals of the Biden administration are, which are several, and they’re quite different from what was in place during the Trump administration. First of all their goal is to work on inequality, racial discrimination. They intend to spend a good bit of time, and money, and effort on climate change. Labour is another emphasis point for the Democrats. And also I think their goal is also to improve international relations. So that was not really a strong point in the Trump administration, and we should expect more focus there. So as far as sectors go, maybe if we start with the Democrats’ goals overall seem to us to help out the U.S. consumer. So quite a number of parts of the discretionary sector, and probably a lot help for small business, and people generally. So think dollar stores, spending at Walmart and Target, et cetera will probably see some good support. Trade is another file that’ll likely get a lot of help here from a Biden presidency. So U.S. companies that export and have relations, in particular with China and Asia more generally ought to benefit. The Biden administration’s likely to focus on infrastructure. And so we do expect quite a lot of money to be put against that. And think of infrastructure in terms of probably two big buckets. One being things climate related, which might be things as simple as credits to upgrade your air conditioning and heating system in a home, or in a business, and also maybe to make your business or home more energy efficient. So those kind of things are quite likely. The use of renewables is likely to be a huge force for the Biden administration. And so maybe one other thing—it’s not all going to be good. The changes with the Biden administration likely bring about an attempt to undo some of the regulations that the Trump administration put in place, and I think here mostly that’ll be in the area of energy, which would be a negative for supply. Strangely, the Trump administration was supposed to be energy friendly, but the sector got pummeled, as you know. Not just due to the administration, but what might happen in the Biden administration is that supply will shrink. At least in terms of U.S. supply. And we might find ourselves with a better energy price for the companies that survive. So it could be an interesting change there. The last part is that a president can change—even in a divided government a president can change certain things through regulation, and I think this will be a focus for the Biden administration. Probably in finance, so in the financial area, as well as in energy. And I think we should expect a lot of change in those two areas.

What themes or rotations are you noticing within the market?

There is a lot of interest in what’s going under the index level, and I think this is where stock picking is going to be the most important thing going forward because the action really is below the surface. And these rotations between a number of things; growth to value, large cap to small cap, and even something like U.S. to rest of world, that’s another transition which may occur particularly in 2021. I think first you need to consider the starting point. A lot of these relationships are extreme. Growth has opened foreign value tremendously over the last 10 years. In fact more than a double—depends on how you look at growth and value, but the spread is enormous. So value has really been a laggard. A lot of value names are in the banks and energy, and so those two sectors become quite important in this discussion. But one thing we can say for sure is that the starting point is quite interesting. But there are three kinds of value probably to consider. First the banks and energy. Second perhaps are more cyclical things found in materials and industrials. And the third source of value is the group of stocks that were directly hurt in the pandemic. And a lot of those, you know, people use the phrase the scene of the accident. But a lot of those are, I think, quite interesting, and I have put quite a bit of money into that. If we start with the banks and energy, that’s a place where those two sectors have become much smaller parts of the market, but the banks do trade, a lot of them right around near tangible book, and I think exposure to capital markets and the credit environment are likely to be quite supportive of the banks. As long as the yield curve can steepen some. As far as energy, it’s possible that we do have tightening of the energy market, particularly as a vaccine rolls out, and the economies of the world begin to grow quicker in 2021, demand for energy, and in particular demand for jet fuel, is likely to tighten the market considerably. And that could lead to better performance in energy, but it is not for the faint of heart. In terms of the scene of the accident, where probably the most interest should be, those companies lie in places that are travel related, for example. Airlines, hotels, restaurants, things in entertainment, even theme parks. You can think of a number of theme parks. Instead of people going to theme parks they kind of tried to do what they could in their local neighbourhood, but you can imagine that there’ll be more overseas flights to Europe in 2021 and 2022 in particular. And I think that auto is another place where we’ve seen some significant demand and that probably persists into 2021.

Why have dividend stocks not performed better?

It’s true the dividend part of the market, or the dividend yield as a factor, has been a laggard. One of the reasons for that has been that the dividend factor, or companies that pay higher dividends, are part of the value bucket. And so since value has lagged the market, and especially growth over the last decade it has really been difficult for the high-yielding companies of the S&P to outperform. And again, many of them are found in the banks, and in the energy sector, as well as some of the cyclical parts of industrials, and also parts of the old tech part of technology. So my guess is that going forward, and what I’ve seen since interest rates bottomed in early September, is that higher-dividend-paying companies have started to outperform on days, in particular, when yields go higher. And the reason that that is so is because higher yields typically mean that the growth outlook is improving, and with that we should expect an expansion of the number of companies that outperform, and that should include some of these value type areas of the market. Now I don’t specifically focus on high-dividend-paying companies. In fact, my focus has always been on dividend growth. Since I think that a company may have a dividend yield of 1.5%, but if it grows at 8% or 10% you do better over the longer term anyway in that one than a slow-growing company with the more—with a larger dividend up front. So I think dividend growth will continue to be a source of upside, but we should expect some improvement of the performance of higher-dividend- paying stocks going forward.