EQUITIES COMMENT – “Surprise Surprise”
Onward and Upward
The strength in equities during 2016 was a big surprise for many market watchers. We have not seen more than a modest pullback in stocks since the Brexit vote in June. Contrary to normal seasonal patterns (strength in the spring and weakness in late summer/fall), the TSX has been in a steady uptrend for six months. Stocks are benefitting from increased buying due to an improved economic outlook that has a lot to do with Trump’s proposed spending plans. As well, expectations for rising bond yields (when yields rise, bond prices fall) due to higher inflation under Trump has resulted in money being shifted from bonds to stocks.
Cyclicals Lead the Way
Mining stocks topped this year’s rally with a gain of 39% on the back of higher industrial metals prices like copper and coal. The rise in gold fizzled due to renewed strength in the U.S. dollar. (Gold and the dollar tend to be inversely related.) The energy sector was up 31% due to the recovery in oil that was buoyed by the oil production sharing agreement. Industrials and Financials had returns close to 20%. Utilities, consumer discretionary and telecommunications provided solid returns of 8% or more (in line with the long run return on the stock market).
“Is the market ahead of itself?”
Our research indicates the TSX is currently fairly valued assuming earnings come through as expected. We have revised our 2017 target slightly to 15,650 from 15,500 which would generate a return including dividends of 5%. This projection could be too conservative if oil and other commodity prices hold their gains or increase further. A critical level to monitor will be the previous all-time high of 15,658 which was reached in September 2014. If the market moves decisively above this level, it would enter a new trading range with upside to 16,600. In the near term, we would not be surprised to see the TSX consolidate near current levels or experience a modest decline to 14,500. Investor enthusiasm about Trump’s agenda could wane due to the time it will take to implement policies and the fact that the U.S. economy is near full employment with a 4.7% unemployment rate. What this means is that if growth accelerates, inflation may also increase. The Federal Reserve would then be inclined to raise interest rates at a faster pace. Also, substantial protectionist trade action could slow economic growth. Other developments that could weigh on stocks would be negative growth surprises from China, the triumph of Eurosceptic political candidates in upcoming elections, a bank failure in Europe, military strife involving China and/or financing difficulties in Emerging Markets. (Some countries have issued U.S. dollar debt that now costs more to service and repay due to the rise in the dollar.)