Canadian small caps expected to ride recovery wave

Small-cap stocks are expected to continue outperforming their larger-cap counterparts during the recovery, says Patricia Nesbitt, senior vice-president and portfolio manager with Mackenzie Investments.

“We’ve seen very significant outperformance by small-cap stocks relative to larger-cap companies, be it looking at the [S&P]/TSX small-cap index or the Russell 2000 in the U.S.,” she said, adding that the trend bodes particularly well for Canadian small-cap funds, which are skewed toward cyclical sectors like energy.

According to Nesbitt, sectors that will benefit from stimulus investments and strong consumer spending include consumer discretionary, industrials and information technology (IT).

“I would highlight the consumer discretionary sector, with household saving rates very significantly elevated,” she said. “We expect continued strong discretionary spending from North American consumers.”

Companies in the industrials sector — including rail, trucking, engineering, construction consulting and waste removal firms — will benefit from the recovery, Nesbitt said. She added that IT businesses like information management, supply chain management and e-commerce systems should boast compelling secular growth opportunities.

“We’ve even warmed up to the financial services space here recently with the outlook for credit provisioning, reversals looking quite favourable, strong capital markets performance [and] very healthy capital levels within all of the banks. And now, with interest rates looking to at least no longer be a headwind for the sector, that’s led us to increase our exposure to the space.”

Conversely, she’s limiting her exposure to health care stocks — particularly cannabis, which she described as highly speculative with rich valuations and over-inflated growth expectations.

She is also underweight gold companies, calling them “difficult businesses with spotty track records [and] large geopolitical risks.”

She added that commercial real estate faces an uncertain future after the double setbacks of Covid lockdowns and the rise of e-commerce.

“Occupancy trends are so uncertain as we look out over the next several years,” she said. “It’s hard to know when folks will be back into offices. And we know the retail experience is obviously going to look very different as we move back into whatever the new normal is going to be.”

Despite those reservations, Nesbitt is bullish on data centres, which she described as critical to internet ecosystems like e-commerce, autonomous driving, e-health and a variety of cloud applications.

She particularly likes California-based Equinix Inc., a REIT that specializes in the data centre space. Equinix boasts growing earnings, a global footprint and compelling revenue growth in an industry that is aided by strong tailwinds, she said.

Among Canadian equities, she likes Winnipeg-based Boyd Group Services Inc., an operator of collision repair centres across North America.

“They are a leading consolidator of this industry, which remains highly fragmented. This stock will be a clear beneficiary of the reopening of North America in the year ahead,” she said, describing the company as well managed with opportunities to grow both organically and through acquisition.

Nesbitt also highlighted Montreal-based transport and logistics company TFI International Inc. “It offers a great exposure to a recovering industrial economy, accelerating e-commerce trends, and, through recent acquisitions like UPS Freight, should continue to post a tremendous top and bottom-line growth,” she said.

She’s also a fan of Waste Connections of Canada, based in Vaughan, Ont.

“Not sexy, but [an] important business,” she said, praising the waste management company’s “strong management team with [a] very strong organic and acquisition-backed growth strategy.” She also pointed to Waste Connections’ strong free cash flow and dividend growth.

Also on her Canadian scorecard is CGI Group Inc., a Montreal-based multinational IT consulting company, and OpenText Corporation, a Waterloo, Ont.-based developer of enterprise information management software.

The expected factor rotation from growth to value will not change the way she and her team assess opportunities.

“We know from our collective professional experience that, over time, the market recognizes the kind of companies that generate superior returns on capital for their shareholders, regardless of some of these near-term cycles and rotation between themes, per se,” she said.

Her advice to investors?

“Stick to your disciplines and over time those get rewarded.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.