Sunny outlook for equities, especially in the U.S.
“We’re kind of in a bit of a sweet spot,’ BMO officer says
As financial markets stumbled badly on Monday, investors saw the outlook getting worse for equity investments, particularly gold and commodity stocks that dominate the Canadian market.
Markets recovered their balance Tuesday, but fundamental questions remain: is China facing a hard landing, and will that worsen the prospects for commodity prices that are so closely tied to economic activity in Asia?
Paul Taylor, chief investment officer at BMO Asset Management, says the issue is no longer a hard or soft landing in China. “We feel China has already landed.
“It’s more a question of what the self-sustaining pace of economic activity will be.
“There is still lots of huffing and puffing in Congress but the macro risk in the U.S. has been put off to the side.” PAUL TAYLOR, CHIEF INVESTMENT OF
FICER AT BMO ASSET MANAGEMENT
Is it 7 per cent, 7.5 per cent or closer to 8 per cent?”
What has been most jolting in the current environment is the relative underperformance of the Canadian market, with its heavy weighting toward natural resources. “The conditions are just not there for a sustained uptick in commodity prices — it’s become ever more apparent.”
Metals, gold and oil have all lost momentum and that’s occurring as China delivers only modest growth. That could mean the long-term cycle in commodity prices is now over.
The upward trend began in earnest a dozen years ago; before that the Canadian market was a huge laggard behind the S&P 500 in the U.S.
But Taylor is not quite ready to say the bull run in commodities is done. After all, the world’s two most populous nations, China and India, have just started going through an urbanization process that normally should last for decades.
And despite the market slip-up this week, there’s reason to look positively on equities, particularly those in the U.S., he said.
BMO’s portfolios are overweight in U.S. stocks, with a less favourable bias toward Canada. The asset class with the least amount of value right now is bonds and fixedincome investments, with yields barely equalling the rate of inflation.
The case for equities now rests on a more favourable macroeconomic environment. Go back 12 or 15 months and markets were dominated by fears of sovereign credit risk in Europe. The structural risks in the eurozone haven’t gone away, but there is at least a framework now to deal with them.
And the level of risk in the sovereign debt market has diminished significantly, not-with standing the recent banking crisis in Cyprus. “We’re on a lot better footing.”
In the U.S., investor focus has been on fiscal problems and budget issues. The risk of going over the fiscal cliff was averted, although further measures must be taken to bring debt into line with the size of the economy.
“There is still lots of huffing and puffing in Congress but the macro risk in the U.S. has been put off to the side.
“As you look at the U.S., trends are quite supportive” of economic activity averaging around 2 per cent through this year “but with an improving trend once we get to the end of 2013.”
By then, he figures, the consumer should have digested whatever payroll tax increases or other forms of fiscal tightening might come along.
The tailwinds behind the U.S. economy look considerable, particularly housing, which has bottomed out and started to mend. The U.S. consumer has deleveraged, the auto industry is doing better, and cheaper energy from domestic sources is now a part of the economic mix.
The abundance of low-cost energy is a significant change that promises to improve productivity down the road, while offsetting the relatively high value of the U.S. dollar.
Earnings growth in U.S. stocks will be modest, he says, but still in positive, singledigit territory and investors get a stock multiple that’s reasonable.
As well, they get the bonus of a central bank that is very easy on monetary policy.
“We’re kind of in a bit of a sweet spot right now where you get a little bit of earnings lift, maybe a little bit of multiple expansion with investors feeling better. You get some dividend yield to tack on to the capital appreciation. It’s an easy bet to make.”