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Canadian stocks and bonds to buy when interest rates and inflation rise

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Jessy Bains
·4 min read
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A trader works on the floor of the New York Stock Exchange (REAUTERS)
Recovery stocks like Air Canada have been getting a bid while several tech stocks are well off their highs (REUTERS)

High-flying growth stocks like Tesla (TSLA) and others — ignore GameStop (GME) as it marches to the beat of its own drum — bounced back after fears of inflation and rising bond yields took a toll on their share prices over the past few trading sessions. If it was just a dead-cat bounce there are a number of Canadian stocks to capitalize on a rotation from growth to value.

The tech-heavy NASDAQ, which also contains several stay-at-home stocks like ZOOM (ZM), doesn’t typically do as well under these conditions. It led the way during the COVID-19 pandemic but has faltered as prospects rise for an improving economy and despite today's snapback is down almost 7 per cent from its recent all-time high.

“Economic recovery leads to rising inflation expectations (or perhaps more precisely, diminished fears of deflation/stagnation) which leads to pro-cyclical rotation among stocks and industries in the market,” Brian Madden, senior VP and portfolio manager at Goodreid Investment Counsel, told Yahoo Finance Canada.

The NASDAQ is off its record high (Yahoo Finance Canada)
The NASDAQ is off its record high (Yahoo Finance Canada)

It could bode well for a number of Canadian stocks if the rotation into pro-cyclical stocks returns, because these types of companies are plentiful on the TSX. Madden says basic materials, industrials, energy, and financials would be winners in that kind of environment.

“Stocks like NFI Group (NFI.TO), Royal Bank (RY.TO), Canada Goose (GOOS) and Suncor (SU.TO) should all stand to benefit under these conditions, and indeed we own all of them,” he said.

“Stocks like Loblaw (L.TO), Metro (MRU.TO), and Cargojet (CJT.TO) would be less favoured and could easily be seen by investors as sources of funds to sell and reinvest in some of these more pro-cyclical themes.”

Shopify could be vulnerable

Darren Sissons, VP and partner at Campbell, Lee & Ross, says higher interest rates, and a recognition that the economy is recovering, have been bigger factors than inflation. So money is moving out of a narrow band of stocks.

“For example, Air Canada (AC.TO) was a disaster last year, but this year it's getting a bid because people are looking through and saying okay at some point people are going to travel again,” he told Yahoo Finance Canada.

Sissons doesn’t own Air Canada, but he does own TD Bank (TD.TO) and Scotiabank (BNS) and says financials will benefit from an improving economy.

“I think the story on the banks just generally moving forward is you're going to see a situation where people are going to start to spending some of their savings, and that ultimately has to go through the banking system.”

Sissons says a recovery in oil and more people driving, when the coast is clear after vaccines are rolled out, means Alimentation Couche-Tard (ATD.B.TO) could also benefit.

He also likes ATCO (ACO-X.TO) for its 27 consecutive years of dividend increases as well as BCE (BCE.TO).

He says expensive stocks that were doing well and are now shorted, like Shopify (SHOP.TO) are vulnerable. He also sees trouble ahead for businesses like DoorDash (DASH) and Peloton (PTON).

Don’t bail on bonds

Alfred Lee, portfolio manager & investment strategist at BMO Global Asset Management, says equities will continue to outperform.

“Interest rates are low so investors aren’t earning anything by being in cash,” he told Yahoo Finance Canada.

“Bond yields are also rising, which may force people to rotate some of their bonds into equities.”

Lee also likes financials and suggests BMO Equal Weight Canadian Bank ETF (ZEB.TO) and BMO Equal Weight U.S. Bank ETF (ZUB.TO) for gaining exposure without picking specific stocks. He also likes energy stocks and companies that are innovating.

With that said, Lee says it isn’t time to go all-in on equities and dump bonds altogether because of the stability they provide to a portfolio.

“There’s a lot of perfection currently priced into the market right now as valuations are very rich,” he said

“Forward looking earnings per share are already pricing in an economic reopening. Fixed income should be used as a hedge in case there are delays in the vaccination roll-out, that may prevent the economy from opening up and limiting many corporations from meeting these earnings targets.”

He says investors should allocate at least 10 per cent of the fixed income portion of their portfolios to areas that do well in rising rate environments.

Lee suggests rate reset preferred shares, and U.S. TIPS (Treasury Inflation Protected Securities) while avoiding bonds with longer maturity dates as the long-end of the curve has been rising.

Jessy Bains is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jessysbains.

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