Today, I’m going to provide you with my thoughts on some sectors and identify potential winners and losers for the next 10 years. This is a result of my own thinking which has evolved from research I’ve done and analyses I have read. This is obviously an exercise of mental gymnastics that could have led to a completely different conclusion if it was done by someone else. This article is not written with the intention of changing your entire portfolio or the way you think but rather to give you some thoughts and ideas to consider.
While the basic materials sector isn’t my favorite, we can fairly say that it has generated interesting results over the past 21 months. However, the ETF underperformed the overall market now that the hype for many commodities has slowed down.
First, gold had its run during the panic, but quickly faded away (again). I’ve been telling you this since DSR was founded in 2013. Gold is nothing but a bet on fear. Now that this part is gone and we know we will manage to survive the pandemic, gold has no place in your portfolio. Many experts predicted $3,000/ounce for Christmas 2020! Don’t fall into this trap.
Second, someone lit a fire under lumber prices. The demand for lumber (especially in the construction world) went berserk as everybody felt the need to have a “new home” (via renovation or literally, a new home). As is often the case with materials, we just went through a cycle and the demand is now slowing down. I believe low interest rates and the momentum in the construction industry will continue to sustain a strong demand for lumber. It won’t be as crazy as last spring, but you can expect a few more good years for companies in this industry.
Third, metals like copper are on the rise. Here’s a classic story for this sector. Underinvestment reduced the supply of copper, and then when demand from electronics and the construction industries increased the price for the material pops! We have seen the price of iron ore and aluminum rise as well. Overall, metal prices will fluctuate according to China’s demand.
I believe the run for commodities is, once again, cyclical. Therefore, now that everybody talks about it, you are likely too late to enter this cycle. We can see that gold has its price increases end once we realized we could fight this pandemic (as with many other events humans have faced over the past 1,000 years). We can see a slowdown in lumber and my guess is that other commodities will follow. With the concerns around the American Government’s debt level and China’s real estate situation, you can expect more fluctuations for the coming years.
Stocks to consider
If you want to go for basic materials stocks, play the long game and focus on very high-quality companies that have proven they can survive a recession without getting close to bankruptcy.
U.S.: Albemarle (ALB) as a leader in the lithium industry and Air Products & Chemicals (APD) and Linde (LIN) for their exposure to something many companies require to function: industrial gases.
Unless you are a big fan of the telecoms (AT&T and Verizon), there are not many dividend paying stocks in this sector. As you can see on the previous graph, the communication services sector outperforms the S&P 500. Unfortunately, this sector has become a copycat of the tech sector since the best performing companies are all considered to be tech stocks (Facebook, Google, Netflix, etc.). This trend is likely to continue for years. Unfortunately for us, most of those companies don’t intend to pay dividends anytime soon. That makes sense as they have multiple growth opportunities, and they create tons of value for shareholders without writing them checks.
While there is significant potential for growth, there is also lots of speculation. Internet content companies, streaming services, and gaming will be the talk of the town for a while. We can easily see how fast those companies will continue to grow as the consumer is continuously looking for ways to distract themselves. Through smart advertising (thanks to incredibly complex algorithms) and subscription-based models, these industries will likely fly to new highs in the coming years. Unfortunately, internet content companies are hard to analyze over the long term as you never know if you are looking at the next Myspace or the next Facebook (Meta). Go with the established leaders where you have reduced risk.
The other big topic in this sector is obviously the development of the 5G technology. So far, it looks like it’s more costly for telecoms than anything else. This is where you must remain patient. Telecoms have invested massively over the past few years (and more money is coming) to build and maintain vast 5G networks. We are talking billions in debt that will likely generate cash flow for decades to come. As you know, building infrastructure is costly and requires time to pay off. AT&T (T) announced a merger, a spin-off and a dividend cut to come in 2022. I believe management is paying for their mistakes (a series of bad acquisitions followed by mediocre strategic integration). I don’t expect other telecoms (BCE, Telus & Verizon) to slash their dividend anytime soon. Please keep an eye on Verizon’s dividend growth year over year though. If you want fast exposure to 5G, go with the technology stocks making smartphones, the pieces included in them, or the chip makers.
Stocks to consider
Disney (DIS) will likely generate more money than ever once movies and parks are running at full speed. In the meanwhile, they just built another incredible asset in Disney +. Viacom (VIAC) remains a speculative play, but I’m still holding my shares as the company trades at a 7 P/E ratio and at a 1.25 Price to Book ratio.
This sector includes a wide variety of industries, but they are all linked to one thing: consumer spending. I’m not surprised to see the sector ETF going up 73% vs 41% for the S&P 500 since January 2020. There are many positive factors that should continue to support growth in this sector. First, while the unemployment rate is still higher than pre-pandemic levels, we can see how fast employers have started to hire again. If you look at economic data (US or Canada GDP), you will see that we had a “V” recovery (meaning the economy plunged and rapidly went back on track). Consumers keep buying stuff at an incredible rate. This will likely have an impact on inflation. So far, inflation numbers have been boosted by gasoline and real estate prices. Therefore, most central banks have been quite patient as they want to see if this is just a temporary effect. As we saw in the basic materials section, some commodities are already slowing down.
The automotive industry (Auto parts, Auto manufacturers, Auto & Truck Dealerships) will likely continue to thrive for several years. We are currently going through a chip shortage affecting some cars, but overall, the need (and interest) for more tech in cars will support an upcycle in this industry. We want more technologically advanced vehicles that will “drive themselves” and will be “greener”.
As many consumers have decided to enjoy themselves a bit more as the pandemic slows down, discretionary spending will continue to be popular. While I’m bullish for this sector in general, I’m still concerned about travel and resorts. Restrictions will mitigate some people’s enthusiasm while increasing expenses for operators.
I don’t think the home improvement and construction wave will continue to surge. I don’t expect a crash, but more like a plateau. In other words, the easy money is gone.
I hope sport and outdoor activities will continue to be trendy and you will find many winners among apparel manufacturers and some specialty retailers.
Stocks to consider
U.S.: Gentex (GNTX) has no debt, have a bunch of patents, and dominates their market. Can you ask for more? Home Depot (HD) has proven it can generate solid growth during the pandemic and has become one of the most generous dividend growers on the market. Starbucks (SBUX) has proven once again it can go through a storm and come out stronger. Finally, VF Corp (VFC) is lagging right now, but it now gives you a good opportunity to grab a higher yielding stock in this sector (almost 3%).
When I reviewed all the sectors back in February, I noticed that consumer defensive stocks were already lagging the market recovery. It is true that this sector had not been affected as much as other sectors when the first lockdowns happened in 2020. The price for lower fluctuations is often a lack of growth when the market goes back into beast mode.
Food, beverages, and discount stores can work as great protection against market crashes. Hint, if you are worried about the next market crash, this may be a good place to start investing. Yields aren’t the most generous and some companies will show P/E ratios over 25, but keep in mind there is a price to pay for protection. If you are looking to sleep well at night, increase your exposure to this sector.
Going forward, inflationary pressures will likely hurt these businesses. Since most of them operate in mature markets, the growth perspectives aren’t that shiny. A combination of limited organic growth, cost of goods and wage increases will lead this sector towards more acquisitions. In many instances, this will be the only solution to offer an interesting narrative for investors.
If you are looking for growth in this sector you must look at discount stores. They have been quite active since the pandemic, and they now count on more robust balance sheets to expand their business and invest in their ecommerce platforms.
Stocks to consider
I like discount stores such as Costco (COST) and Walmart (WMT). They will continue to offer solid results even if we enter a recession. McCormick (MKC) pays a low yield but shows a robust dividend triangle. I’ll repeat here what I have often said, “I’m not a fan of the tobacco industry”. They pay high yields, but they are killing their customer base.
Here’s a surprising graph! Did you expect to see the energy sector not showing a full recovery? I heard so much “good stuff” about the oil industry I thought it would be thriving by now. Unfortunately, it’s not that simple. While the price of a barrel of oil went down way too low during the crash of 2020, the situation is not all unicorns and rainbows right now.
Some experts tell you the barrel will quickly reach $100 since many major oil companies slashed their CAPEX budgets last year and that we will face major delays in production from new sites. In other words, less production capacity while demand continues to increase. This is an interesting narrative, but keep in mind I read the exact same stories in 2011. I’m not saying this won’t happen this time, but I’m just telling you to be prudent.
Another fascinating phenomenon recently happened around natural gas. Prices spiked over the past 6 months due to a long list of factors. First, stockpiles in Europe are low due to growing demand (cold winter) and maintenance work at Norwegian facilities. Second, since prices soared in Europe, North American producers jumped on the opportunity to export as much gas as possible. Mix that with a slowdown in drilling projects and a warmer summer in the U.S. and you have an inventory going down faster than expected.
Don’t go crazy just yet. When I look at Natural Gas companies, they aren’t exactly soaring like the natural gas spot price is. Looking at companies such as Cabot Oil & Gas (COG), Enterprise Products Partners (EPD) and Kinder Morgan (KMI), they aren’t exactly killing it in 2021. This tells you the market believes it’s likely a temporary situation. Did anyone tell you that natural gas and oil are cyclical markets? Well, I’m afraid the story will repeat once again.
I think the best way to play the energy sector is to buy robust companies when the market is down, and experts see no good news coming ahead. 6 months later, the situation is completely different and now, we see commodity prices rising like there is no tomorrow. I’m still not convinced by this story. I would rather play it safe on this side. Nonetheless, there are a few good picks in this industry. Especially if you are concerned about rising inflation. The energy sector is historically a good hedge against inflation.
Stocks to consider
U.S.: I’d go with companies that went through the last energy crisis without slashing their dividend. Companies like Enterprise Products Partners (EPD), Magellan Midstream Partners (MMP) and Chevron (CVX) could be on your list.
Financial services in the U.S. underperformed the market while the Big 6 in Canada did slightly better than the TSX 60 since January 2020. While we avoided the worst (a wave of bankruptcies), there are still concerns about the future of banking. Savings and loans are under pressure as interest rates remain low on both sides of the border. We expect central banks to slow down their quantitative easing strategies (e.g., buying bonds to support lower long-term interest rates). Eventually, rate increases will be welcome. Keep in mind the market is likely going to drop a few points whenever the “threat” of rising interest rates grows. I think higher interest rates are good for long-term economic growth. However, this will slowdown the crazy bull market we are having now. In the end, it will be good if we can get a correction in the coming months. Unfortunately, your guess is as good as mine as to when that might happen.
Asset managers will be in a tough situation whenever the market corrects. There are several threats right now (U.S. debt, Chinese economy slowdown, rising inflation and the pandemic). If any of those factors build a narrative strong enough that the market “buys it”, well, we’ll see a lot of investors selling! In that case, assets under management will decrease and so will revenues and earnings. This doesn’t change the long-term trends where wealth management, retirement planning and ETF investing will continue to dominate this industry. Invest accordingly.
Looking at banks and life insurance companies, they would welcome an interest rate increase. This will increase banks margin (interest rate spread) and will allow life insurance companies to invest in better bonds. The bond market has been terrible for anyone trying to build a portfolio with fixed income (like what life insurance companies must do with premiums received to eventually pay claims). DeFi (decentralized Finance) is also a threat for banks, especially for their loans & deposit activities. At this point, we are talking about a marginal system that is available for “those in the know”. Can it become a large movement and do what P2P (peers-to-peers lending) didn’t become 10 years ago? We’ll see in a few years! In the meantime, it’s best to invest with large banks that are well diversified.
Stocks to consider
U.S.: You’ll find classics like Blackrock (BLK) and JP Morgan (JPM) as they are incredibly robust financial firms counting on well-diversified business models. Morgan Stanley (MS) is impressing me with solid execution and a robust dividend triangle. Bank of OZK surprisingly did well throughout the pandemic and keeps increasing its dividend quarterly (you read that correctly, 4 increases a year!).
As you can see, there are opportunities in all sectors. The key is to select the best performing companies for each industry and make sure they fit in your portfolio. I personally don’t invest in all sectors and I still manage a well-diversified portfolio.
I hope you enjoyed this article,
Mike Heroux, Passionate Investor & founder of Dividend Stocks Rock
P.S. Are you concerned by the current state of the market? I recently hosted a free webinar on What To Buy In This Overvalued Market? Know What to Buy, Know When to Sell. Watch the replay here!
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**Please do your own due-diligence before investing in any stocks we discuss in this article**
I may hold shares of companies discussed in this article.