IN­SIDE THE MAR­KET

The Globe and Mail (Prairie Edition) - - SPORTS | REPORT ON BUSINESS - TIM SHUFELT

Fall­ing stock val­u­a­tions of­fer tempt­ing buy­ing op­por­tu­nity – care­ful tim­ing is a must

As we re­turn to a ‘nor­mal volatil­ity regime,’ mar­kets may be cheap­en­ing enough for a heavy buy­ing spree

The first sub­stan­tial global sell-off in two years hasn’t ex­actly made stocks cheap again, but it’s cer­tainly made them a whole lot cheaper than they were.

For stock pick­ers, who are not best-suited to an era when ev­ery­thing seems to go up with lit­tle de­vi­a­tion, a mean­ing­ful cor­rec­tion was a long time com­ing.

“If we’re back to a more nor­mal volatil­ity regime, then it’s a god­send for ac­tive man­age­ment,” said Brandon Snow, chief in­vest­ment of­fi­cer at Cam­bridge Global As­set Man­age­ment. “I haven’t been this ex­cited in years.”

Though brief, the em­phatic re­turn of volatil­ity has al­ready lopped off big chunks from stock val­u­a­tions in the United States and Canada. And while the mar­ket has re­gained its com­po­sure over the past few trad­ing days, few are writ­ing off the pos­si­bil­ity that the tur­moil is not over.

There are two ways to tame an over­val­ued mar­ket, which is char­ac­ter­ized by un­usu­ally high price-to-earn­ings ra­tios.

The first is to have stock prices fall. The sec­ond is to have earn­ings rise. “Since late De­cem­ber, we have been do­ing both of these,” Ian de Ver­teuil, head of port­fo­lio strat­egy at CIBC World Mar­kets, said in a re­cent note.

Eq­uity in­vestors are by now acutely aware of the re­cent pre­cip­i­tous price ac­tion. In late Jan­uary, an ex­plo­sive run in U.S. eq­uity prices crested and went into a nose­dive, en­ter­ing cor­rec­tion ter­ri­tory in just nine trad­ing days.

The U.S. sell-off quickly went global, drag­ging down Cana­dian, Euro­pean and Asian stocks in­dis­crim­i­nately. The MSCI All-Coun­try World In­dex stopped just short of a cor­rec­tion, with losses of 9 per cent.

On the earn­ings side, mean­while, the ma­jor re­duc­tion in cor­po­rate taxes in­cluded as part of U.S. tax re­form has un­leashed a tor­rent of up­ward re­vi­sions to cor­po­rate prof­its. S&P 500 earn­ings es­ti­mates for this year and next have in­creased by 7 to 8 per cent in the past six weeks alone.

Diverg­ing prices and earn­ings have com­bined to bring for­ward P/E ra­tios in the United States down to their low­est lev­els in well over a year. At 16.5 times as of the end of last week, that rep­re­sents a ma­te­rial cor­rec­tion from the mul­ti­ple of 18.5 just two weeks be­fore.

“That’s a big move, es­pe­cially be­cause it’s not trig­gered by growth fears,” said Vin­cent Delisle, a port­fo­lio strategist at Sco­tia Cap­i­tal. “I think it’s just the mar­ket re­set­ting after an al­most un­in­ter­rupted run.”

And though Cana­dian equities were nowhere near as hot as in the United States over the last year, do­mes­tic val­u­a­tions were hit just as hard.

“We saw an across-the­board liq­ui­da­tion with all kinds of dif­fer­ent com­pa­nies get­ting hit,” Mr. Snow said.

“This is when it gets fun, when you get in­dex flows af­fect­ing all se­cu­ri­ties in the same way.”

Hav­ing sat on a large cash weight­ing for well over a year, Mr. Snow took the op­por­tu­nity to pick up shares in a num­ber of com­pa­nies that sud­denly looked a lot more at­trac­tively val­ued.

He would still like to see prices drop by an­other 4 per cent to 7 per cent be­fore he starts to dip more heav­ily into his cash re­serves.

If the sell-off re­sumes and con­verges on his­tor­i­cal av­er­ages, he could get his chance.

In a typ­i­cal cor­rec­tion, valu­a­tion mul­ti­ples con­tract by about 3.5 points, David Rosenberg, chief econ­o­mist at Gluskin Sh­eff + As­so­ciates Inc., said in a re­cent note.

“The mar­ket usu­ally cheap­ens up a lot dur­ing these cor­rec­tions,” Mr. Rosenberg said, re­fer­ring in this case to the U.S. mar­ket. “The prob­lem is that it hasn’t cheap­ened up enough.”

The same can’t be said for the Cana­dian mar­ket, where the av­er­age mul­ti­ple for the S&P/TSX Com­pos­ite In­dex fell from around 16.5 to 14.5, which is close to, if not slightly be­low, its long-term av­er­age.

“You look around the world, there are not too many places where the for­ward and trail­ing mul­ti­ples are trad­ing be­low their his­tor­i­cal norms,” Mr. Rosenberg

said.

Even if the sell-off is over, and mar­ket bulls have re­asserted their con­trol, Cana­dian val­u­a­tions could prove al­lur­ing to value in­vestors, CIBC econ­o­mist Nick Exarhos said in a note.

“With the dis­count placed on the TSX widen­ing, we think bar­gain hunt­ing might be prof­itable this side of the bor­der.”

This is when it gets fun, when you get in­dex flows af­fect­ing all se­cu­ri­ties in the same way. BRANDON SNOW CHIEF IN­VEST­MENT OF­FI­CER AT CAM­BRIDGE GLOBAL AS­SET MAN­AGE­MENT

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