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The industries set to outperform in 2021

While most of the market is expected to benefit from this recovery, not every sector is tipped to soar.

Most market strategists are in agreement that the cyclical sectors will be the ones to back in the recovery. Simon Letch

William McInnesReporter
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Investors across the board are in agreement 2021 will be a good year for equities. The global recovery story driven by the rollout of vaccines, further fiscal stimulus and accommodative monetary policy is set to light a fire under equity markets and Australia could be a standout.

The domestic economy has already kicked into recovery mode, with state governments effectively restricting the spread of the COVID-19 pandemic, allowing life to largely continue as normal.

While the majority of the market is expected to benefit from this recovery, different sectors will perform differently, with those hit hardest by the pandemic set to benefit in the rebound.

Expectations of a return to above target levels of inflation could prompt some weakness in the high-flying growth names but allow cyclicals and value stocks to flourish. Cyclicals are stocks exposed to the economy and therefore likely to prosper as global growth picks up.

"If we do get inflation up to 2 per cent and the fiscal stimulus comes through, the market is already telling you the deep value [stocks] and cyclicals will benefit," says UniSuper chief investment officer John Pearce.

"You’ve got financials, resources and small caps all rallying while the momentum stocks, tech and bond proxies are falling away."

Most market strategists are in agreement that the cyclical sectors will be the ones to back in the recovery, with the US election and Brexit outcomes removing two key risks for the market.

"If you look at more cyclical sectors, with a number of those key uncertainties removed and three vaccines in place, I think you’ll see more positive developments," says MLC chief investment officer Jonathan Armitage.

"Whether it's around materials or the cyclical industrial companies, those will be the real beneficiaries."

Ausbil Investment Management chief investment officer Paul Xiradis says cyclicals across the board are set to outperform in 2021.

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"We are excited about the resurgence in other listed cyclicals as the economy recovers – including quality cyclical industrials and construction materials, diversified financials and insurance companies, leaders in quality consumer discretionary, the transition and renewable energy complex, patronage infrastructure assets like toll roads and airports, and quality travel companies," he says.

AMP Capital portfolio manager Dermot Ryan says the sectors of the economy most leveraged to domestic spending are likely to perform well too.

"We think the easiest way to make money is to follow the free cash flow and one great area we’ve been long bullish on is domestic spending," he adds.

"We’re seeing strong spending patterns coming through and you’re starting to see high household savings being converted into spending."

Another area of the market delivering excessive free cash flow is the mining sector, driven by soaring commodity prices.

"Mining and resources have been a very interesting space and with iron ore, we’re now at record margins and record production," says Ryan.

"A lot of the battery minerals have also had a large uptick in demand and we’re starting to see pricing and interest in the sector have a bit of a renaissance. We think that’s going to be a very good place to invest for the year."

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With Joe Biden set to step into the US presidency, along with a Democrat-controlled Congress, the resources sector could be a key beneficiary of a shift towards more renewable forms of energy.

"A Biden presidency has already promised trillions in spending and benefits packages that support renewable energy investment in the US, which is expected along with European leadership in renewables to spark similar approaches to renewable energy policy globally."

'Still more to go'

UniSuper's Pearce believes some parts of the sector are looking fully valued but still sees the potential for further upside. "I’d accept the view there’s still more to go here," he says.

The banks are also poised to play catch up in 2021, with rising bond yields and a recovering economy both providing a strong tailwind for the sector.

"Banks are still trading well below their long-term multiples, have experienced less delinquency and bad debts than first thought, and are all well capitalised," says Ausbil's Xiradis.

"With leniency recently expressed by APRA in terms of dividends, we expect a resurging banking sector to return to paying more normalised dividends on the back of a resurging economy in 2021."

Not every sector is set to be a winner, however, with investors still expressing some concern in some pockets of the market.

"We continue to think expectation are still too high in travel and education," says AMP's Ryan. "The vaccine rollout is going to be difficult and that’s going to restrict mobility. It's going to be hard for entertainment stocks in terms of pubs and restaurants and some of the earnings expectations are just too high."

The local tech sector could also be set to take a back seat in 2021 after years of market-leading performances, as bond yields begin to creep higher.

"Obviously, the vulnerability comes from those securities that have been real beneficiaries of very low interest rates," said MLC's Armitage. "That could be growth equities like technology, but it could also feed through to unlisted assets."

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William McInnes
William McInnesReporterWilliam McInnes covers markets from Sydney including editing the Markets Live blog. Connect with William on Twitter. Email William at w.mcinnes@afr.com.au
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Summary | 2 Annotations
cyclicals
2021/01/17 03:19
materials or the cyclical industrial companies, those will be the real beneficiaries."
2021/01/17 03:20