Just weeks into the new year, North American equity markets are off to a strong start. In Canada, the S&P/TSX Composite Index has rallied more than 1,200 points or nearly 9 per cent. Out of the 29 trading sessions year-to-date, the S&P/TSX has closed higher 22 of these days.
Equity markets are being driven higher in part by positive earnings reports. According to a report released last week by Refinitiv, while only 10 per cent of companies in the S&P/TSX have reported their quarterly earnings to date, more than 70 per cent of them have reported better-than-expected earnings. The numbers are also impressive in the United States: Of the 66 per cent of companies in the S&P 500 that have reported quarterly earnings, 71 per cent have reported earnings beats.
Meanwhile, valuations remain attractive. For instance, the S&P/TSX is trading at a price-to-earnings multiple of about 14 times the 2019 consensus estimate, well below its five-year historical average multiple of roughly 17 times.
Will the positive stock-market momentum continue?
Bruce Cooper, chief executive and chief investment officer of TD Asset Management, shared his 2019 market outlook in a recent conversation with The Globe and Mail. Here are highlights.
What is your outlook for equity markets?
We were more cautious last year and then right at the very beginning of this year, we became more positive. There are three reasons. The first is, while we expect global growth to decelerate, we do not anticipate a recession. The second factor, we think central banks are close to the end of their tightening cycles. Third would be valuations. Last year, equity markets broadly were pretty lacklustre. The combination of falling stock prices and rising earnings meant that valuations by the beginning of this year had become more attractive.
What stock-market regions may experience the highest returns?
We tend to think about four geographical buckets: the United States; Canada; what we call international, primarily Europe and Japan; and the fourth bucket would be emerging markets. If we think about those four categories, the U.S. has been our favourite market for a while and we continue to like it. When we upgraded equities in January, we also came out with a more favourable view of emerging markets so those would be our two favourite markets today, U.S. and emerging, with Canada next and international would be the last.
What are your return expectations?
Broadly, for equities we are thinking mid-to-high single digits. I would say we are in a little bit of a lower-return world. Economic growth is slowing, interest rates remain low, equities broadly have been going up for 10 years. I said equity valuations were reasonable. I didn’t say they were cheap, they are reasonable.
Are your return expectations based on earnings growth or multiple expansion?
I think over the next couple of years you are going to get mid-single-digit earnings growth. It wouldn’t surprise me if in 2019, earnings growth was in the low single digits but as you look out to 2020, it could do a bit better than that. It wouldn’t shock me if you got a tiny bit of multiple expansion and the reason for that is we are very firmly planted in the lower-for-longer interest-rate camp.
What stage of this secular bull market are we in?
I think the cycles will be much longer today than they were historically. This cycle has been 10 years, the last cycle was eight years, the previous cycle to that was around 10 years.
Big declines in equity markets tend to be associated with recessions, or put differently, I think equity markets can continue going up over time as long as the economy is reasonably positive. With Canada, we do worry about the high level of household debt. As I mentioned earlier, of our four geographic categories for stocks, Canada is third and certainly the high level of household debt is one of the concerns. I think that will lead to slower economic growth in the country. The other big overhang are the issues around the energy sector, particularly the building of pipelines. So I think valuations in certain parts of the Canadian market will remain depressed until we have visibility on what’s going to happen with pipelines, which is why we are a little more cautious on Canadian equities compared with U.S. or emerging markets.
In late 2018, we saw extreme moves in the market, do you believe 2019 will be a volatile year?
Volatility is normal in equity markets. 2017 was unusual because volatility was so low. There are lots of real issues. Trade is certainly at the top of our list, the dispute between China and the United States is very important. We do expect trade frictions between the U.S. and China to be persistent, they could run for years and years, and during that wax and wane a little bit.
What is a potential catalyst that could lift equity markets meaningfully higher?
When I think about our three themes, central bank easing is probably the one that is most likely a catalyst. We are firmly in the lower-for-longer camp. We think we are close to the end of the tightening cycle. It wouldn’t shock me if there were either zero or one increase this year in both Canada and the U.S.
Even more important is where the 10-year yield goes. We do not see it going meaningfully higher from here. The reason it [has] peaked is because growth is slow so earnings growth will be slow. The good news is, if you don’t go into a recession – as we don’t think we will – it should [help lift] P/E multiples.
Are there certain sectors that you favour?
Within Canada, our Canadian equity funds have been overweight on the banking side. Two themes come together there. One is with [earnings] growth slowing, we think it’s important to stay at the quality end of the investment spectrum – that tends to be our bias at all times but it’s certainly our bias now. Within the Canadian context, banks are very diversified businesses, they have good exposure to the U.S. with many different earnings streams. We think they meet that quality metric. Another thing, in an environment where interest rates remain low, stocks that have good yields and can consistently grow their dividends continue to be very attractive.
Is the low Canadian market sentiment a contrarian indicator suggesting upside for the market?
I don’t think I have ever seen sentiment as negative as it is now in all of my years. I think the biggest challenge for Canada is that we are just not seeing a lot of global interest in our stocks. I think that’s part of what’s depressing the price-to-earnings multiples.
The way I look at it, it should create a long-term opportunity. I don’t know if that opportunity will bear fruit in 2019 or if it will take longer. I think the valuations do embed a reasonable amount of skepticism and negativity about Canada.
Within fixed income, you shifted your recommendations.
At the beginning of the year, when we upgraded equities, we also upgraded investment-grade corporate bonds and high-yield bonds and downgraded government bonds. This is fairly consistent with a more risk-tolerant approach and the impetus for that was that spreads last year widened quite a bit on corporate debt.
What’s your call on the Canadian dollar?
We are cautious on the Canadian dollar. Our bias would be for it to continue to deteriorate, albeit modestly. If you think about the two big negative drivers, high debt and this oil challenge, both of those will tend to impede investment.
With gold off to a strong start in 2019, is this a time to be bullish on bullion?
We are neither here nor there on gold. We tend to view it as portfolio insurance and because we are relatively more optimistic now [on equity markets], our feeling is that the need for insurance is not high.
Do you hold a perspective that deviates from consensus?
I think we are differentiated in that we have turned more optimistic this year after having been more negative last year.
This interview has been edited and condensed.