McMurtry Investment Report & Model Portfolios

McMurtry Investment Report Newsletter – June 2021

How to position Cyclical / Value Sectors relative to Growth / Defensive Ones

I posted a blog on May 13th regarding the outlook for cyclical stocks in this equity market after their strong recent performance. More specifically I used Rio Tinto, a global mining conglomerate to compare its share price performance vs the S&P 500 Index. I also provided a stock market valuation of the company using the industry standard EV/ EBITDA ratio. My conclusion was that Rio Tinto’s share price continued to outperform the overall equity market at the early stages of the last recession and only started to go down several months after the overall market fell at the beginning of the recession of 2007-2008. Secondly it was clearly evident that Rio Tinto’s market valuation was still considerably below the last peak valuation.

Since my last blog on Rio Tinto, the US monthly inflationary stats have shown a very dramatic pickup in domestic inflation. While the US Federal Reserve Bank indicated that this uptick is largely short term in nature, with the sharp increase in prices for airlines, hotels and other services that had been largely shutdown previously in the middle of the pandemic, the jury is still out on the transitory nature of these inflationary numbers.

To clarify things even more, I have included several graphs on the US global copper and gold producer, Freeport- McMoRan. The first graph shows how the company’s share price outperformed the overall equity market for several months at the beginning of the 2007-2008 recession before backing off more towards the middle of the recession. This graph clearly indicates that Freeport’s share price lags on the upside relative to the market, but that it also lags on the downside in a bear market. One can deduce from both the graphs of Rio Tinto and Freeport- McMoRan is that these commodity type stocks should continue rising more than the market until another recession is very clearly evident by the overall market decline. There is no need to prematurely sell them until there are imminent signs of another economic recession. The other graph shows how Freeport’s market valuation has greatly fluctuated since the last recession. Over the past thirty years Freeport’s EV to EBITDA trailing valuation has peaked in 2005-2006 at 18 times and in 2021 at over 22 times. However, the current valuation is down to 12.45 times and if you use projected Forward EBITDA the ratio is down to 7.5 times. Consequently, in my opinion there is still considerable upside.

After the very strong performance of copper and other commodities, the Chinese government is trying to force down the prices by imposing stricter import guidelines and threatening substitutions if available. Historically when they attempted this in the past, it was purely for the objective of making purchases at cheaper prices for themselves. Although the Chinese can affect prices on a short- term basis, their methods are unlikely to cause any long- term affect on prices.

For most commodities there is no credible substitute that is as effective as the metal in question. Consequently, this is not likely to affect pricing in any material way.

It is important to differentiate and assess the supply / demand prospects for every metal and commodity before making blanket generalities about all commodities. For example, lumber prices have gone crazy for the last year or so despite the recent pullback. Differing from other commodities lumber is renewable and can be easily regenerated without long term depletion. Through modern technology, replanting methods have improved considerably over the years and this applies both to the quality and length of time to regenerate. Consequently, I am not nearly as positive on the outlook for lumber prices as I am for other commodities.

On the other hand, the fundamental outlook for copper is much more promising with additional supply taking many years to come on stream. Crude oil is also in a relatively short supply situation once OPEC uses up its spare capacity. US shale production has very much peaked and this is positive for pricing. However, we all know that renewable energy poses a serious long- term threat to the crude oil industry, but not as much over the immediate and short term. Investors who want to participate in the cyclical pickup in the global economy need to invest in energy companies at this time.

In a cyclical recovery it is not really demand that is an issue for commodities. The real issue lies in how quickly production supply can be increased to meet the rising demand. As I indicated previously, every commodity has a different fundamental outlook for supply increases and investors need to be very much aware of this before investing.

At some point interest rates are going to rise once again to control rising inflationary pressures. In a period of rising rates, cyclical / value stocks tend to outperform technology and defensive stocks.


I would continue to emphasize cyclical / value sectors over growth / defensive ones. Cyclical industries like Financials, Energy, Materials, Industrials and Consumer Discretionary should continue to outperform Technology, Consumer Staples and Healthcare.

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