Gains driven by less stretched valuations and more leverage to the global economy
TORONTO, Jan. 14, 2014 /CNW/ - Canadian stocks are likely to outperform American stocks in 2014, finds a new report from CIBC World Markets Inc.
"After being trounced by New York - and Europe and Japan for that matter - in 2013, Toronto stocks entered the year with less stretched valuations, and greater potential for earnings gains that will pay off in outperformance in the year ahead," says Avery Shenfeld, Chief Economist at CIBC.
Mr. Shenfeld, who co-wrote the report with CIBC Senior Economist, Peter Buchanan, notes that Canadian stocks also have more leverage to a rapidly heating global economy than do their U.S. counterparts.
In its most recent forecast, "Outlook 2014: Give Low Rates a Chance", CIBC economists call for 2014 to be the first year since 2010 in which global growth surprises on the upside. They are calling for growth to run at a four per cent pace, about a half-point above current consensus or International Monetary Fund expectations.
Historically, years in which global growth ran at four per cent or better were big winners for the cyclically weighted Toronto Stock Exchange, producing median returns well above the S&P 500. Mr. Shenfeld notes that the "TSX has outperformed the S&P in each of the last six years in which global growth has topped four per cent and 2014 should add to that streak.
"That reflects the heavier weighting in Toronto's benchmark towards resources sensitive to global activity. To this point, sluggish activity has held back demand, in a period in which supply was expanding in such areas as natural gas, oil and base metals. Little wonder, then, that the resource sector has been largely responsible for a disappointing earnings recovery of late, offsetting steady gains elsewhere in the index."
However, he believes the increases in supply for oil, natural gas and metals are already well priced in. "What isn't, is the pressure from demand associated with pleasant surprises in global economic activity," adds Mr. Shenfeld. "That should have oil prices steady but oil futures trading at much less of a discount than now in the curve. Natural gas could hold onto recent gains, while base metals and lumber move higher."
The report calls for TSX composite earnings growth to run a consensus-topping 13 per cent in 2014. Last year, CIBC Economics' top-down model, which is based on a set of macroeconomic, cost and resource market indicators, accurately anticipated a disappointing low, single-digit pace for TSX composite earnings. The report also calls for the S&P 500 to roughly match bottom-up earnings expectations with growth of about 7.5 per cent, trailing the TSX pace.
Mr. Shenfeld notes that forward price-to-earnings multiples also seem favourable to a year in which Canada lands on top. "Though stocks aren't wildly cheap on either side of the border, the TSX's current multiple of 14½—close to the historical average—is well below that for the S&P 500. Toronto's average dividend is higher, and many investors feel dividends are a better guide to longer term profitability than current earnings, suggesting dividend-rich players should trade at a premium. Controlling for compositional differences between the markets suggests the typical Toronto-listed stock trades for about eight per cent less than the average large cap member of the Big Board."
While he is calling for Canadian stocks to perform to the upside, Mr. Shenfeld expects some of that advantage could be eroded by a further slide in the Canadian dollar in the near term. "The loonie is still vulnerable to another few months of the low inflation readings that have had the Bank of Canada talking more dovishly about future rate moves.
"For now, Canadian asset managers will want to keep some of the U.S. dollar exposure they've built up, perhaps doing so on the fixed income side. We'll need to see more improvement in Canada's trade position as the year progresses, and an uptick in inflation that quells dovish talk from the Bank of Canada, to put a floor under the loonie."
Mr. Shenfeld believes the Canadian dollar will fall below 90 cents U.S. by next summer. The currency should bounce back to current or higher levels by the end of the year should marginally higher inflation and reasonable growth see the Bank of Canada renew its warnings of rate hikes in 2015. He also expects growth in oil and other exports should also help narrow the trade deficit, a gap that has been a feature while Canada's domestic demand outgrew that of its customers abroad.
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijan14.pdf.
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SOURCE CIBC World Markets