A rising Canadian dollar, strength in multinational industrial stocks and base metals prices combine with manufacturing data to highlight an accelerating global economy. The weight of evidence is compelling and investors should tilt their portfolios toward economically sensitive growth stocks, rather than defensive equities, for as long as the trend holds.
Copper prices have jumped 15 per cent since the May lows and the first chart below provides the explanation. Industrial metals prices in general – here represented by the S&P/GSCI industrial metals index – follow the trajectory of global manufacturing activity. This makes perfect sense, as improvement in manufacturing activity increases demand for resource inputs.
Aerospace giant Boeing Co., with a stock higher by 14 per cent in the past few market sessions, and heavy equipment maker Caterpillar Inc. are only two of the industrial stocks with a global market where rising stock prices confirm a strengthening world economy. The second chart below, from Singapore-based Vanda Research, shows the relative performance of U.S. cyclical (economically sensitive) and defensive stocks. A rising line indicates outperformance by cyclical market sectors.
The five-year chart shows a gradual improvement of U.S. cyclical stock performance versus defensive sectors. Since June, 2016, however, the pace of cyclical outperformance has accelerated. This coincides with the sharp upswing in the JPMorgan manufacturing index in the previous chart.
The underperformance of defensive stocks has important ramifications for dividend-focused investors. The same industries where investors look for dividends – utilities, consumer staples, telecommunications and health care – make up the majority of the index of defensive market sectors. In other words, the underperformance of defensive stocks also implies the underperformance of dividend stocks.
Investors have, of course, been previously confronted with optimistic global growth outlooks in the postcrisis period, only to be disappointed by the resumption of sluggish, mediocre economic expansion. While it is always disquieting to base portfolio changes on a "this time is different" theme, Deutsche Bank strategist Marcos Arana noted that we are seeing "the most synchronized [global] growth environment in the last six years" in a recent report. Mr. Arana predicted the global economy would expand by 3.6 per cent in 2017, up significantly from 2016's 3.1 per cent.
In light of previous economic head fakes, investors shouldn't completely change their portfolio weightings away from defensive sectors and into cyclical stocks. But particularly for those looking to take some profits in dividend sectors as central banks push bond yields higher, a tilt toward more economically sensitive growth investments seems prudent.
Scott Barlow