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So far this year, Canadian stock performance continues to lag major U.S. indexes. A narrowing of that gap is overdue, according to the chief investment strategist at BMO Nesbitt Burns.Getty Images/iStockphoto

A strong earnings season is unfolding on both sides of the border, but in only one of those markets are stocks ringing in new all-time highs.

Second-quarter profits in both Canada and the United States are handily beating analysts' estimates, adding to evidence of a recovery from the recent downturn in earnings.

But Canadian stock performance so far this year continues to lag major U.S. indexes.

A narrowing of that gap is overdue, according to Brian Belski, chief investment strategist at BMO Nesbitt Burns.

"The tough start to the year for equities is unjustified and a surprise back half recovery is likely," Mr. Belski said in a note to clients, emphasizing that "earnings and profitability continued to rebound from 2016 lows."

In the United States, the quarterly flood of financial results is coming to a close, with 85 per cent of companies in the S&P 500 index having already reported. Nearly three-quarters of those companies came in ahead of earnings estimates, with all eleven sectors surprising to the upside.

Tech stocks have posted the biggest surprise growth, which has helped wipe away the memory of an early-summer sell-off in Big Tech, when the market became concerned about valuations. Beats by companies such as Facebook Inc., Apple Inc., and Oracle Corp. have set the sector up to exceed sell-side estimates by 11 per cent, according to data from Thomson Reuters. For the S&P 500 index as a whole, the quarter is expected to see growth in earnings over the prior year of 12 per cent, which would make for the second consecutive quarter of year-over-year double-digit earnings growth – a feat the U.S. market has not achieved since 2011.

"Based on bottom-up consensus forecasts, quarterly S&P 500 earnings should continue to advance at a double-digit growth rate over the next 12 to 18 months," writes Vincent Delisle, a portfolio strategist at Scotia Capital.

The profit outlook is also drawing strength from this year's precipitous slide in the U.S. dollar, which has made U.S. goods more competitive in the global market.

The combination of earnings strength, global macro improvement and the moderate pace of monetary tightening by the U.S. Federal Reserve has propelled U.S. benchmarks to new highs this summer, Mr. Delisle said.

The Nasdaq composite and the S&P 500 indexes both set new records in late July, while the Dow Jones industrial average ended last week in record territory, after having broken through the 22,000-point mark for the first time. The Dow and S&P 500 have advanced by 11 per cent to 12 per cent so far this year, while the Nasdaq has surged to an 18-per-cent gain year-to-date.

What's most encouraging about the latest leg in the uptrend is that rising earnings estimates have actually pushed trading multiples slightly downward since the start of the year, according to Ed Yardeni, president and chief investment strategist at Yardeni Research.

"That's a very healthy development," Mr. Yardeni said. "Valuation multiples remain highly elevated, of course. But it isn't a melt-up if stocks are rising along with earnings rather than on higher valuation multiples."

That's where the parallels between the Canadian and U.S. stock markets end.

While Canadian valuations have also stabilized, and Canadian earnings are also in an expansionary phase, equity prices have been stagnant.

The S&P/TSX composite index is just about the only major market index to be in negative territory on the year (though it's down just 0.2 per cent). This, despite second-quarter earnings tracking toward an 18-per-cent year-over-year gain.

There are some important caveats to the strong Canadian earnings season, however.

About half of the profit growth is attributable to the energy sector, which is benefiting from easy comparisons with depressed results last year. And this year's renewed slide in crude-oil prices has seen Canadian oil and gas profit forecasts steadily revised downward.

The buoyant loonie, meanwhile, which has been lifted by strong readings of the domestic economy, Bank of Canada hawkishness and U.S. dollar weakness, has cast a shadow on the earnings rebound by hurting Canadian exporters.

Regardless of the pressures, Canadian stocks have probably been unfairly punished this year, said Mr. Belski, who pointed to resiliency in the financial sector.

"With the Canadian dollar bottoming and financials not imploding, we smell a surprise recovery coming in the back half of 2017."

Rob Carrick has a summer project for you saver's out there - challenge your reliance on big banks for the best interests rates and research some alternatives.

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