It has been a volatile year for Canadian equity investors, with the S&P/TSX Composite Index plunging in February, bouncing back to a record high in July and subsequently retreating more than 1,000 points by October. The index lost further ground on Monday and has now nearly made a return trip back to the lows set in February.
Brian Belski, the chief investment strategist at BMO Nesbitt Burns, expects more volatility in the weeks ahead. But the next major move, he thinks, will be higher, driven in part by strong corporate earnings.
Despite concerns surrounding trade tensions and rising interest rates, Mr. Belski believes Canadian fundamentals are the strongest they have been in several years. He highlights that seasonal trends also provide encouragement: When the S&P/TSX Composite has reported muted returns of between negative 5 per cent and positive 5 per cent during the first three quarters of the year, as is the case this year, it has almost always delivered a positive price return during the final quarter of the year.
He recently discussed his bullish outlook with The Globe and Mail.
Last year, you made a call for the S&P 500, anticipating the index would reach 2,950 by the end of 2018, a target that was nearly reached several months early. In September, the S&P 500 closed at a record high of 2,931, less than 1 per cent away from your base case target. Unfortunately, the S&P/TSX is in negative territory year-to-date, remaining well below your base case year-end prediction of 17,600. Yet, you believe this target is still potentially achievable.
In Canada, multiples went down a lot further than we thought but earnings have actually been pretty good. We think the negativity surrounding the North American free-trade agreement, loan growth, a housing bubble and the spread between Western Canadian Select and WTI [West Texas intermediate] just had everybody so negative on the macro data.
I think we are going to see earnings come out in Canada that are going to be very good. I think you are going to have a rush of assets, from an equity perspective, coming back into Canada over the next three to six months.
From a historical perspective, we have seen very strong fourth quarters with respect to performance in the TSX index that can get us very close to our 17,600 target.
In a strategy report that you published last month, you indicated that, looking back to 1935, the index has rallied more than 8.5 per cent during the fourth quarter 20 per cent of the time – an impressive figure.
One of my primary themes for six years now as a strategist at BMO has been as America goes, so goes Canada. If you apply a common sense overlay of the two countries, we are aligned geographically, we are aligned with respect to culture, we are aligned with respect to trade, we are each other’s No. 1 trading partner, there is no reason why we should not be excelling at the same time. Earnings and GDP between the two countries over the past six years has become increasingly correlated like they were in the 1980s and 1990s. Canada’s fate is not tied to gold prices, copper prices or oil prices; it’s tied to the strength of the North American economy that’s driven by the United States.
We could see a buying exhaustion [rally] in November, December and here’s why. I think there are a lot of people negatively positioned heading into the end of the year. I think there is a very good chance that there could be another surprise in the U.S. election this year, like there was in 2016. I think that people are negatively disposed and just getting the election out of the way could lift stocks higher. I don’t think that politics drive stock prices. I think they can either enhance or detract [from] the trajectory but they do not define stock prices. Fundamentals drive stock prices. I would say once we have clarity on the mid-terms, you could see a buying exhaustion that could surprise people and that the Canadian market could come along for the ride.
Investors could see the price-to-earnings multiple expand for the S&P/TSX Composite Index?
I think there is room for multiple expansion because of this whole notion of chasing performance. I think a lot of portfolio managers have underperformed this year and they are going to need to own stocks that are performing and you are going to get a big lift in financials, I think, in the fourth quarter.
Speaking of financials, the S&P/TSX’s largest sector weighting has not reported a gain year-to-date. Are investors looking forward to 2019 and concerned about decelerating earnings growth?
I think investors are using any kind of potential negative data point as a reason not to invest. Canadian CEOs are still playing defence – underpromise and overdeliver – when you look at the financials sector, in particular. I think the numbers are too low across the board because CEOs of companies are playing defence.
There is this reigning negative still overshadowing what we think is a pristine fundamental environment.
So why will financial stocks rally?
You are going to see money come back into Canada ... and guess what [these investors] are going to buy? They are going to buy the large cap stocks such as Royal Bank, TD Bank and Bank of Montreal.
What are your thoughts on emerging markets and European markets?
All you have to do is turn on the television [to hear], "Buy emerging markets because it's cheap". I don't buy stuff because it's cheap. That's what everybody told you at the beginning of the year, buy Europe because it's cheap, how did that work out? Not very well. You buy an asset because it is working and that is why Canada can, will, and should go higher. From an earnings perspective, earnings are going up.
Last year, your sector overweight recommendations were financials, industrials and materials. At present, you still favour financials and industrials but switched your materials call to energy. Why the change?
Emerging markets have been underperforming, copper prices have been going down. We booked our gain in materials, which had been outperforming for a long-time and made the switch into energy because U.S. energy earnings went up but Canadian energy earnings have yet to go up, which is why we made the call, and we do think that Canadian oil companies do a much better job on a fundamental basis at managing their companies in a trading range [an oil price trading range] environment versus the United States.
Last month, at a BMO conference you described your Canadian market outlook by stating, “Mundane is Good”.
Mundane is good. I would take single-digit positive performance. Bond investors are going to lose money this year so what are they going to buy?
I believe Canadian investors are fantastic buyers and owners of equity income, buying companies that are growing their dividends over time. We don’t just buy high yield companies, we want to buy companies that are growing their dividend over time.
Did you know two things? The U.S. financials sector is the strongest dividend growth sector in the world for the next five years and Apple Computer is one of the strongest dividend growth companies in the world.
You have held a long-term bullish stance for equity markets. What gives you this conviction?
I initially came out with my secular bull call, my 20- to 25-year bull market call, in 2010 and I still stand behind that call.
At 11-per-cent earnings growth next year, that’s double the average since 1990 on an annual basis. I think the number one thing that people are missing is that the consensus earnings estimates are too low.
Everyone is so focused on earnings going down next year, they are not focused on the potential for earnings to go up next year.
What could derail your bullish market forecast, at least temporarily?
Corporate America retrenches and starts playing defence and really starts cutting their [earnings guidance] numbers.
The other thing that bothers me is that a 12-day correction isn't enough. We had a big move up in the markets but we had a 12-day correction in February. You need a bit of washing out.
We will have a cyclical bear market within my big secular bull call. The likelihood of a 15- to 20-per-cent pullback in the S&P 500 is very likely, very normal.
When could this occur?
We’re a few years away from that.
This interview has been edited and condensed.
Jennifer Dowty is investment reporter and equities analyst with The Globe and Mail.