Healthy earnings rebound
After several quarters of falling earnings, a healthy rebound in corporate profits is underway, driven by an improving economy and reduced headwinds from oil prices and currency fluctuations. Consensus expectations are for double-digit earnings growth this year. Importantly, this is being helped by rising sales, not just cost cutting. Revenues for 2017 are expected grow at more than twice the pace of the past two years.1
More average-looking returns
Canadian Large-cap stocks are up 19% over the past year and the S&P 500 has returned 17%.2 We think conditions are supportive of continuing gains given ongoing economic growth, rising earnings and a still-helpful interest rate environment. However, we believe more moderate, mid-single-digit annual returns are reasonable over the balance of this bull market as current valuations (P/E ratios are above 17 for the TSX and S&P 500) are already pricing in the earning rebound and monetary policy will slowly become more restrictive, versus increasing stimulus in recent years.
Prepare for pullbacks
Prominent elections in Europe, the execution of Brexit negotiations, the Fed's slow but steady removal of stimulus and uncertainties associated with the Trump administration's pro-growth policies will all serve to instigate higher volatility over the balance of the year. Additionally, market valuations already reflect a fair degree of optimism, leaving less margin for error. The current fundamental backdrop is sufficiently solid to make a pullback a buying opportunity, in our view. There have been a few dips and two 10% corrections in the past three years and the average stock market increase in the following six months was 7.9%.3
Action for Investors
We recommend a combination of offense and defence. Within a neutral weighting to equities, exposure to small- and mid-cap equities will benefit from faster economic growth in North America. Additionally, we recommend buying the dips in stocks as the fundamental backdrop remains positive. To play defense, broaden asset class diversification and proactively rebalance sector allocations by trimming overweight exposures to domestic financials and other cyclicals, rebalancing into underperforming areas such as health care, telecommunications and consumer staples.
1. Bloomberg, consensus expectations for S&P/TSX index and the S&P 500 index for fiscal year 2017.
2. Bloomberg, total return.
3. Bloomberg, price change in the S&P 500 index.
This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events. Past performance is not a guarantee of how the market will perform in the future. Indexes are unmanaged and are not available for direct investment.