The S&P/TSX Composite Index paused from its 11-day winning streak on Tuesday, ending the day with a slight loss of 0.1 per cent. However, the S&P/TSX is less than 2 per cent away from its record closing high set back in January.
Since bottoming in early February, the index is up over 1,100 points or 7 per cent, getting a major assist from a rally in energy stocks (the energy sector has an index weighting of nearly 20 per cent). Furthermore, the market rebound since February has been broad-based, with nine of the 11 sectors in the index delivering positive price returns.
Is the Canadian market ready to recapture another record high? Kurt Reiman, BlackRock’s chief investment strategist for Canada, thinks so. In an interview with The Globe and Mail, he shared his latest thoughts about equity markets, Canada’s currency, and how investors should position themselves.
What are your expectations for the stock market?
The bull market still has room to run as does economic expansion, and it will be measured in years.
Are you referring to global equity markets or the Canadian equity market?
I think about it from the initial framing of global equities and that Canada has a place in that.
What are your return expectations for the S&P/TSX Composite Index in 2018?
I think we are going to get growth in the TSX this year that will be pretty close to the earnings growth number. I think that the earnings forecasts for the TSX are roughly about 12 per cent earnings growth this year and somewhere just shy of that for 2019. If there is multiple contraction, I think it’s going to be concentrated in the dividend yield sectors, and I really mean those that are not growing their dividends.
How should investors position their portfolios?
Our posture has been bracing for the potential of higher interest rates so you would be underweight the bond proxies, sectors that have an above-average dividend yield and don’t grow their dividends, and seeking out more of a return from sectors that have sensitivity to the cyclical economy, which would be technology, financials and selected energy companies, specifically exploration and production companies. It also helps that this is where, in some respects, the market is cheap and also where earnings growth is quite strong.
The way I look at it, Blackrock’s iShare ETFs can be grouped into four segments - Canadian stocks, U.S. stocks, Canadian bonds and international stocks. What allocation would you recommend to investors?
Broadly speaking, we would be overweight stocks versus bonds for starters.
Right now, because of this one-time boost to earnings from the tax cuts in the U.S., we are favouring the U.S. market. We are talking 24 per cent, potentially, earnings growth this year and the market has already factored in a fair amount of the tax cut boost and the move higher in interest rates but what it hasn’t priced in is the resilience over the course of this year and into 2019 of stronger-than-expected earnings growth coming from the top line with margins maintained.
Then a close second, or maybe tied for first, the next destination would be emerging markets. When I was listing my sector preferences, I said technology and financials, and the largest sectors in emerging markets and the U.S. happen to be technology and financials so there’s a little bit of synchronicity in our sector preferences and our regional preferences.
What gives you this confidence in the markets and the economy?
I think the first place to start is to look at the global economy and there we’ve seen some deceleration in economic indicators but most are pointing to a sustained expansion, and growth will be stronger in some places compared to others. For example, the U.S. stands out, near the top of the chart in the developed world, because of the one-time fiscal stimulus boost, which should resonate over the next couple of years.
We also have something we use to gauge what’s happening over the next year and that’s called our BlackRock macro GPS and over the next year it’s saying that in the U.S., we will get economic activity somewhere in neighbourhood of 2 3/4 per cent and in Canada close to 2 per cent.
There are recession concerns with the yield curve flattening.
Some of these worries today about an impeding recession, to me, are a bit premature.
The yield curve is flat some people will say, and I would caution against using that as a telltale sign that a recession is imminent. Flat yield curves don’t really have very good predictive power, inverted curves do, and while the curve may be very flat, it’s not inverted. There is some indication that as the year progresses we’ll see long-term yields move higher as compensation to investors for a still strong economic backdrop but also some firming in inflation.
Are you still expecting just one more rate hike by the Bank of Canada?
For the balance of 2018, yes, and it can change.
The Canadian economy is getting a bit of an uplift from better activity south of the border and I do think that [Bank of Canada Governor Stephen] Poloz and the rest of the team have this very much in their line of sight.
Inflation is not deeply in the red zone, the economy is not operating substantially above potential, and given the Bank of Canada’s concern about the interest-rate sensitivity of the economy, I think that really augurs for a go-slow approach relative to what the Fed is doing.
South of the border, we think we could get as many as four rate hikes over the course of 2018 and for the Fed to stay on the path heading into the first half of 2019 of roughly one rate hike per quarter.
What are your expectations for the Canadian dollar relative to the U.S. dollar?
High to mid-70s [in U.S. cents] is about where we have been, on average, this year. I think it’s going to be tough for the loonie to appreciate much. I think one thing that is notable is that oil prices have risen so much and it seems like the Canadian dollar is completely oblivious to it. Sometimes the most importance forces, oil and rate differentials, completely offset each other and we’re in one of those windows right now. I think the Canada dollar is going to be range bound over the course of the year in this mid-to-high 70s level. I don’t think it has the potential to appreciate much from here.
For stock investors, it’s, in general, probably not a good idea to hedge out the currency risk. Typically, taking on currency risk is a good thing, it reduces the overall risk in the portfolio.
What are your thoughts on the marijuana sector?
I think the way to categorize this is that it’s not something you can ignore any more and it’s probably not going to be an investment for everybody because even though it may not be as taboo, it’s not accepted everywhere equally and there are legislative risks. If you look at the price action, it’s also indicative of an early stage, nascent industry.
We have to keep our eye on the centre of the circle here if we want to get the directionality of the market right, we’re going to have to get our calls on the dominate industry sectors right.
In terms of growth versus value, do you favour a particular strategy?
We look to the value factor for better performance. When we look back in historical periods and break up the business cycle, we would say we are still in that expansion phase, where value tends to be one of the better performing factor tilts.
We would highlight value along with earnings momentum. We have just seen historically outsized revisions to earnings this year and into 2019 and that should help those companies that have historically been delivering those earnings, they are going to continue to do so and that should support their share prices.
Do you expect market volatility to persist?
I think it’s going to look more like a low vol regime than a high vol regime for the balance of this year but I think it’s going to be higher than what it was last year and the year before.
This interview has been edited and condensed.