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Time ripe to buy base-metals stocks: CIBC

STEVE LADURANTAYE

Monday, May 11, 2009

Stopping just short of declaring the dawn of a new multi-year bull market, CIBC World Markets told investors Monday to load up on base-metals stocks to position themselves for an economic recovery.

“Base metals historically have been among the first resource-space movers, meaning that related equities have historically tended to outperform the market in the late stages of recession and early in recovery,” chief economist Avery Shenfeld said as he released the brokerage's investment strategy update.

He said China's apparent resurgence – with rising metal imports and increasing factory activity – suggests the early stages of a broader Asian recovery may be at hand.

“Industrial activity is indeed already picking up, not in green shoots in North America, but in bamboo shoots in East Asia,” said Mr. Shenfeld, who maintained his 2009 target of 10,800 points for the S&P/TSX. “Factories there are sparking back to life.”

While the materials subindex on the Toronto Stock Exchange has gained 8.5 per cent so far this year, Mr. Shenfeld moved to an “overweight” position, saying that “although the base metals sector has been one of the market's best performers of late, stocks are still trading about 50 per cent below levels reached during the boom.”

Mr. Shenfeld also upgraded his outlook for Canada's financial sector, saying that the markets are now “convinced” U.S. banks will not be allowed to fail and take down other global financial institutions with them. While still not bullish, he said the banks should be able to weather the losses they are all but certain to absorb this year.

“The doomsday scenarios that took financials down to six-year lows are looking increasingly unrealistic, removing a serious downside risk,” he said. “Those fears were fanned across the border from the flameout that hit Wall Street banks last year, with Canadian financials, for a time, driven in a tight correlation to U.S. majors.”

While optimistic in tone, suggesting “we're in the early stages of a bull run for stocks,” Mr. Shenfeld warns that a pullback is likely in the coming months as recovery comes more slowly than investors seem to be anticipating.

“As any rodeo fan will tell you, bulls don't offer a smooth ride,” he said. “Markets suddenly jettisoned their fear of depression and looked ahead to an economic recovery. We, too, see the economy reviving before year end, but the rally looks a tad early and more vigorous than what we typically see when there's only limited evidence of such a turning point.”

Here are highlights of the report's sectoral analysis:

Consumer discretionary: “We expect conventional TV and newspapers to take the majority of the hit from the hostile ad markets, with radio holding on reasonably better. The earnings outlook for media is directly correlated to the economy, which remains depressed.”

Consumer staples: “Consumer behaviour has changed, with a definite shift towards private label, increased shopping frequency, smaller basket sizes, eating at home, and shopping to paycheques. Capital spending is generally down dramatically as every company tries to preserve cash.”

Energy: “While we believe current valuations are attractive, we continue to see soft prices and tight credit as a shorter-term concern, thus making balance sheet strength a top priority for investors.”

Financials: “Despite tight credit conditions, we believe that conservatively capitalized commercial and residential REITs will be successful in refinancing their maturing debt and in financing the limited amounts of largely pre-leased development activity that they have under way.”

Industrials: “While the steel sector is currently in the midst of the worst industry downturn in decades, some initial signs of stabilization may emerge over the next few months. The steel industry will likely remain challenging into 2010; however, we expect end-market demand will at least improve over 2009.”

Information technology: “With organic growth likely under pressure due to the macro environment and with valuations declining to attractive levels, we expect consolidation in the sector to accelerate. Valuations appear reasonable, with the sector trading towards the lower end of the trailing five-year average.”

Materials: “The recent correction in input costs and currencies should ensure that top-line growth remains high, since cost inflation should begin to wane. We believe this margin expansion will set the stage for a new influx of investors who will see the earnings power of the industry take hold while at the same time provide some degree of safety from general market mayhem.”

Pipelines, utilities and power: “We continue to believe that such a level of implied equity risk premiums offers considerable long-term value for investors, given our view such a level (consistent with current liquidity crisis-induced corporate bond spreads) is an overstatement of the appropriate equity risk premium for companies in the sector, and is likely to decline in the medium to longer term. We continue to prefer pipeline companies over the utilities, given stronger growth expectations for the former.”

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