Canadian equities to buy in current environment

With inflation looking like it’s starting to creep back into the market, Canadian stocks appear ready to stage a comeback.

They could use it, as the S&P/TSX Composite Index is down slightly in the past 12 months, compared to a gain of 13 per cent for the S&P 500.

Yet the strong inflationary bias that characterizes Canadian equities as a whole, doesn’t necessarily bode well in the type of environment being seen today.

Brian Belski, chief investment strategist at BMO Capital Markets, noted that the TSX typically outperforms during periods of structurally rising inflation and interest rates, while a cyclically rising rate environment favours U.S. equities, and early cyclical stocks in Canada.

Unfortunately for Canada, it appears we are in the latter scenario.

“Indeed, periods of structural pressure are often characterized by spikes in energy prices which tend to benefit Canadian equities,” Belski said. “To be clear, we do not believe this is the current environment and continue to expect energy prices to remain range bound, with higher interest rates driven by cyclical, not structural pressures.”

Cyclical periods of rising rates are characterized by yields increasing faster than inflation, expanding economic growth, and manageable inflation.

During these periods, Belski noted that non-resource cyclical stocks outperform, and defensive stocks underperform. While stocks on both sides of the border usually benefit, U.S. equities typically do better.

Structural periods of rising rates, which benefit Canadian stocks most, typically see inflation rising faster than yields, and the bond market and the Fed are “behind the curve,” which hampers economic growth.

In this scenario, the strategist highlighted the outperformance of resource equities and underperformance of consumer-related stocks.

Since inflation expectations are well-contained, Belski is confident that we are in a period of cyclical rising interest rates. In this scenario, he favours more cyclical sectors and industries in the TSX, particularly technology, consumer discretionary and industrials.

Belski noted that energy and financials usually outperform slightly, while materials underperform significantly.

Outside of the Big Three sectors in Canada (energy, materials and financials), BMO highlighted some its favourite names.

In consumer discretionary, Canadian Tire Corp., Roots Corp., Canada Goose Holdings Inc. and Restaurant Brands International Inc. are rated outperform.

Among industrials, the firm’s favourite names include Air Canada, Boyd Group Income Fund, CAE INc., Canadian National Railway Co. and Finning International Inc.

As for technology stocks, BMO rates CGI Group Inc., Kinaxis Inc. and Open Text Corp. at outperform.