There are two ways of looking at Canada's benchmark index. One, it's a global laggard with year-to-date returns of less than 8 per cent, trailing U.S., European and Japanese stock market indexes by double digits. Or two, the S&P/TSX composite index is doing just fine if you ignore underperforming energy stocks and the big drag from materials.
Of course, stock markets always look good if you ignore the bad bits and focus on the good. The question is whether you can discern the two ahead of time. Indexers say you can't, and stock pickers say you can– which makes Brian Belski, chief investment at BMO Nesbitt Burns, more of a stock picker.
In a strategy update for 2014, Mr. Belski argued that Canada's benchmark index will generate low single-digit returns next year, finishing at 13,575 – underpeforming more diversified markets. (On Monday morning, the index was at 13,428, so his forecast implies a gain of just 1 per cent from the current level.)
"While stocks were able to recoup their earlier losses in 2013 thanks in part to a second-half recovery, a lack of discernible and consistent fundamental growth speaks to the volatility that is likely to persist, in our view," he said.
As he sees it, the problem is that emerging markets and Europe continue to deleverage, or cut back on debt and government spending, while the commodities market suffers from overcapacity.
But wait: There's no need to avoid Canada. He believes that the key to success is to focus on two key sectors.
Financials should perform well as investors shift more of their holdings away from bonds and into stocks, driving demand for wealth management services – and stocks like Bank of Montreal, Manulife Financial Corp., Royal Bank of Canada, Toronto-Dominion Bank and Sun Life Financial Inc.
"Given our view that interest rates are gradually headed higher for a prolonged period of time, we believe this reallocation trade is in its very early stages of becoming a burgeoning trend," he said. "This is particularly good news for certain areas within financials, since we believe the heavy fixed income focus has been largely responsible for dwindling stock market volume and commissions/fees paid."
He is also expecting strong performance from industrials – particularly those that don't rely on Europe and emerging markets.
"Industrials will continue to benefit from the relatively stable and consistent growth in the U.S.," he said. "Furthermore, it is the volatility of business conditions in emerging markets and Europe that we believe will ultimately force capacity to return to the U.S. and Canada, thereby fuelling the North American manufacturing renaissance and capex for that matter."
His favourite Canadian industrials: Bombardier Inc., CAE Inc. and Canadian National Railway Co.
David Berman