Laggard TSX may be ready to get a boost

The S&P/TSX Composite index was the only major stock market in the world that failed to advance in the first half of 2017, but things may be starting to look up for Canadian equities.

While the S&P 500, Dow Jones Industrial Average and Nasdaq Composite continued to hit new all-time highs, and global equity markets pumped out a total return of 10.1 per cent in the first six months of the year, Canadian stocks lagged due to stagnant oil prices and housing concerns.

But weak stock prices have made for more attractive valuations, just as global economic momentum is poised to improve in the second half of the year. As a result, Canadian stocks could finally get the lift investors have been waiting for.

Stéfane Marion, chief economist and strategist at National Bank of Canada, increased his allocation to Canadian equities last week, in anticipation of a stronger global economy. “This development argues for a reflation trade scenario, implying a somewhat weaker U.S. dollar and stronger commodity prices,” Marion told clients. “That should buoy the S&P/TSX.”

He highlighted the fact that the TSX Composite is trading at a significant discount to the S&P 500, as the spread between the 12-month forward P/E ratios of the U.S. benchmark and the TSX is the widest since 2004.

David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates, also pointed to this valuation gap, noting that it leaves the U.S. stock market nearly four times as expensive (on a standard deviation basis) as Canada is.

He believes the technology, health care, materials, energy, consumer discretionary and financial sectors all offer compelling valuations. However, tech and health care suffer from lack of choice, and energy and materials require calling commodity prices correctly.

Rosenberg noted that if the Bank of Canada follows through with a couple of interest rate hikes, Canadian financials will see some margin expansion, and the recently rebounding loonie will provide a much-needed boost to retailers that import consumer products.

Recent comments from Bank of Canada governor Stephen Poloz suggest the central bank is getting ready to remove the emergency stimulus that was brought in during 2015, and may raise rates as soon as the July 12 meeting.

Nick Exarhos, an economist at CIBC World Markets, believes there is good reason for the Bank of Canada to eye a rate hike before the end of the year: growth looks hot.

“Combined with what should be a muted backdrop for equities stateside, better domestic readings and an improving global sentiment on Canadian assets should see the TSX outperform in the second half,” he told clients.