Equities broadly have turned in a strong performance in 2017. The TSX has largely moved sideways, while U.S. and global markets have logged double-digit gains. A chaotic political atmosphere and shifting monetary stimulus are likely to stoke volatility, but fundamentals are signaling more room for the bull market to run.
Bloomberg and Morningstar Direct, 12/31/2016. Canadian Large-cap stocks represented by the S&P/TSX Composite. U.S. Large-cap stocks represented by the S&P 500. All returns in local currency and total return.
Rotating leadership – This bull market is more than 3,100 days old, making it the second-longest on record. With a total return of 342% for the S&P 500 and 165% for the TSX since the bull market began, the market’s highest returns are likely behind it. However, we think there’s more life left in this bull cycle. As we progress, we expect market leadership to rotate, across asset classes and among equity sectors.
Earnings in the driver’s seat
– We expect market gains will be driven by increasing corporate profits. TSX earnings face some challenges given the dependence on bank performance and commodity prices; however, a more sector-balanced measure provides a positive outlook. Broadly, profit margins remain above-average and economic growth supports rising revenues. Corporate tax reform in the U.S. would also provide a boost for S&P 500 profits, though we continue to believe comprehensive tax cuts face delays amid the political climate.
Be ready for pullbacks
– Stock market volatility has been near record lows lately, but we caution against complacency. The VIX (volatility) index has been below 10 recently, compared to a 20-year average of 20.6. Since 1997, when the VIX fell below 10, volatility rose, on average, by 25% within the following three months.
Action for Investors - Prepare for additional volatility by rebalancing overweight equity allocations and preparing to buy the dips. Correlations among asset classes have fallen recently, a trend that rewards broad diversification. Maintain an underweight position in Canadian equities and consider adding to domestically underrepresented sectors such as technology, health care and consumer staples/discretionary.