While the S & P / TSX Composite Index staged a major comeback at the start of 2019 and is up approximately 15 per cent year-to-date, it’s relatively unchanged from where it was one year ago. Since the beginning of 2018, the S & P / TSX Index has repeatedly stalled around the mid-16,000 level. In the current environment, active portfolio management including sector rotation, stock selection and country and industry exposure diversification have become increasingly important for investors to employ in order to achieve attractive returns.
A recent interview with The Globe and Mail, Kurt Reiman, BlackRock's chief investment strategist for Canada, shared his market expectations and thoughts on how investors may want to position their portfolios for the second half of 2019. available to subscribers online at tgam.ca/inside-the-market.
What is your outlook for the months ahead?
Equities still have more upside from here. Earnings estimates for the next 12 months seem pretty reasonable, maybe they are a little bit optimistic but not too bad. Canadian earnings have been holding up remarkably well relative to other regional markets. When you look at valuation measures, the market doesn't appear overly stretched.
They are the predominant drivers of the macro environment, they are the most affected by the macro environment, they are more affected. For example, we retain our overweight in the U.S. and that is reflecting that fact that U.S. economic growth, even though it's slowing, is the best in the developed world. The U.S. equity market is heavily weighted towards sectors that have what I would call structural growth dynamics, like technology and health care. The U.S. equity market has shown that it is able to consistently deliver higher returns on equity and valuations are not stretched. We have lowered our exposure to emerging markets, we have lowered our allocation to Japan equities, we have lowered our allocation to Asia, ex-Japan, also from neutral to an underweight.
[Our] view is that markets have priced in too much optimism with regard to China's efforts to stimulate its own economy. In a best case [scenario], we expect China's economy to stabilize but at a weaker level, and this will have a material impact on the emerging market complexes.
Also, we reiterate our preference for a minimum approach, or to have a minimum screen volatility to keep the portfolio from not moving around too much. For Canadian investors, if they were to take a minimum approach, they would end up diminishing their portfolios, which is focused on financial, energy and materials, some of which are cyclical and value-oriented parts of the market. taking] higher allocations in some of the more defensive sectors. We think that is a reasonable approach because of value-oriented companies don’t typically perform during periods when we are thinking that the economy is going to be slowing down or heading into recession. In fact, that's when value performs the worst. Value performs when you are starting to recover.
I don’t think returns will be as good as they were in the first half. The still think investors are going to be rewarded for gaining exposures to equities, but it’s really important [to be tactical] about which markets and the weightings.
What are your expectations for the second quarter earnings season?
When it comes to the second quarter earnings, what is changing [management's] thoughts around global supply chains, global value chains, and how they are thinking about their own capital spending plans. Some of the weaknesses in growth is coming from business sentiment and business investment. So I want to see what CEOs are saying about their own visibility on their runway for future growth because they are going to be thinking about it. that is something that is maybe a bit underappreciated. Lastly, I would like to know what companies are reporting on whether or not they are going through consumers. We will be thinking about what effects tariffs will have on either profit margins or consumer price inflation.
Should investors be taking profits ahead of second quarter earnings announcements as management outlooks may be cautious?
No, I don't think I would be taking profits here. I would still be looking to invest with an eye towards the next six to 12 months.
We are going to drive macro outcomes and what's going to drive us volatility in markets but because we have central bank policy support, this is likely extending the economic cycle to what it might be otherwise. Financial conditions are easier as a result. Earnings growth is holding up and the markets are not particularly expensive here. I would be favoring holding an overweight to equities.
One idea – it was a great year for bond investors, 6 for cents or returns in government bonds and maybe 8-per-cent returns if you went into investment-grade or high-yield bonds. Those are great numbers for a bond investor. Where I may be thinking about taking a little bit of risk out of the long-term government bond market where yields are quite low. For investors who may be making more changes to their portfolios than others, something to think about shortening the maturity profile of their government bonds or holdings and considering if they need to raise cash or if they need income, investment investment. grade bonds. If they are willing to take risk, perhaps even looking into emerging market debt.
When your 10-year Canadian government bond is only giving you a yield of 1.6 per cent today, it may make sense to think about what your portfolio is of interest rates continuing to fall, rather they move to bit higher.
From a valuation perspective, how much potential upside do North American stock markets have?
When I have said the equity market looks fair, I have been speaking about the U.S., which is effectively in line with its five-year average [on a price-to-12-month forward earnings basis]. Canada, on the other hand, is almost 10 per cent below its five-year average. The energy [sector] is 50 per cent below its five-year average.
Returns over the next year or so, but not from earnings and dividend growth. Looking out on the next year, earnings growth is [forecast to be] in the mid-to-high single digits for both the U.S. and Canada.
Are the sector ratings, such as the performance of the S & P / TSX composite index year-to-date, value traps?
Broadly speaking, value managers have been through an extended period of underperformance.
I think it is probably safe to say that energy is something of an opportunity – but I would probably be selective here. Companies that are involved in the pipeline or mid-stream energy companies or companies that are integrated and have broader operations. I think there are opportunities within energy. There are always opportunities within the value space.
In June, gold rallied to a six-year high. What is your outlook for this subsector?
I think there are pluses and minuses around gold. For sure, the geopolitical risk equation is driving gold prices higher. There has been a revision of economic forecasts and central banks, and they have been lowering rates at a time when inflation expectations are moving lower. That means that real yields are falling and when real yields fall, gold prices tend to rise. Gold does not provide any income. I know how to produce assets or government bonds.
Do we think that interest rates are going to continue to move down? I think that it is reasonable, but we are probably pretty near the cycle lows . It does that optionality on it if geopolitical tensions more broadly or U.S.-China tensions should get worse.
You believe the Bank of Canada will keep rates on this year, is that correct? What direction will it be – up or down?
Yes, it is. I think that the path is the least resistant. If inflation is a little bit Probably not. On the other hand, if you invest or spend your money in your business. I think that would be good enough to get the bank down. now.
Right now, our forward-leading indicator for Canadian [economic] growth seems pretty solid at around 1.75 per cent over the next 12 months, and that's moving higher since the beginning of the year. Canadian [economic] data has been sequentially surprising to the upside. Cheap currency, fading effects of NAFTA uncertainty, stable commodity prices, quite possibly the growing appeal of technology within Canada, I think that will be more relevant topic to think about. I don’t mean semiconductors, servers and clouds, but I mean green tech, clean tech, resources tech, AI [artificial intelligence] and machine learning, robotics and e-commerce. There is a lot of things we can look to as future support to growth.
When we last spoke in the fourth quarter of 2018, you believed the Canadian dollar would be bound with some bias to strengthening relative to the U.S. dollar – a accurate forecast with the Canadian dollar locked around the mid-70-cent level.
I feel like a broken record and I don't mean to be. I thought it was reasonable between 75 and 78 cents and I don't have any reason to change that. I still think that this level is keeping Canadian economy competitive and is not impaired to growth.
Lastly, a significant proportion of people's wealth is in their homes. What is your outlook for this asset class – real estate?
One policy added to another and another is that it has on housing. Foreign buyers taxes, the net effect of rising short-term rates and the impact of accumulating, but they don’t accumulate in a linear fashion. Starts at make buying at home for people who are marginal pretty difficult buyers. I don´t know if we have seen much change – all the macroprudential policies are still there. Five-year fixed-rate mortgages may fall short of the five-year government bond yields fell so many this year but still those higher hurdle rates stress-free mortgages to contend with certain regional markets. I think all these effects remove the broader housing contagion risk to the Canadian economy, which I think in the long run is healthy.