Equity Market Update: Climbing the wall of worry

Transcription

1 RBC Dominion Securities Inc. Equity Market Update: Climbing the wall of worry Patrick McAllister October RBC November Dominion 2,2018 Securities Inc. Presentation Title

2 Agenda 1. Several factors conspiring to roil equity markets 2. U.S. economic outlook remains positive 3. Trade risk fading but Canada-specific challenges remain 4. Parting shots

3 Several factors conspiring to roil equity markets

4 Volatility is Back (Again) Reminder that the low-volatility of 2017 was the exception not the rule S&P VIX Source: Bloomberg 4

5 Volatility is Back (Again) Reminder that the low-volatility of 2017 was the exception not the rule S&P VIX Source: Bloomberg 5

6 Volatility is Back (Again) Reminder that the low-volatility of 2017 was the exception not the rule S&P VIX Source: Bloomberg 6

7 Bull Markets Aren t Always a Smooth Ride 7

8 Name a Reason to be Nervous About the Market And the survey says PROTECTIONISM 23 WASHINGTON 12 INFLATION 15 VALUATIONS 9 BUSINESS CYCLE 13 GEOPOLITICS 6 CENTRAL BANKS 12 8

9 Equity Markets Follow a Pattern in Midterm Election Years Long Odds on a Worst Case Scenario S&P 500 Returns Around Midterms ( ) Probability the Democrats Control House Senate 83% 17% 80% 13% 64% 14% Source: RBC Capital Markets, Bloomberg, FiveThirtyEight, Iowa Electronic Markets, PredictIt 9

10 Passing the Peak in Earnings Growth S&P 500 Earnings Growth 30% 26.6% 24.9% 20% 21.5% 20.0% 20% 10% 0% -10% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q Source: RBC Wealth Management, Thomson Reuters 10

11 U.S. economic outlook remains positive

12 Cumulative economic growth U.S. Economic Expansion Getting Long in the Tooth? Expansions do not die of old age Length of Economic Expansion (Measured by # of Quarters) Source: RBC Wealth Management, St. Louis Federal Reserve 10

13 U.S. on Solid Footing with Low Risk of Recession U.S. Recessionary Indicator Scorecard Signal New York Fed Recession Probability Model - - Bloomberg Recession Probability Model - - Yield Curve - - ISM Manufacturing - - Capacity Utilization - - U.S. Real Policy Rate - - Conference Board LEI - - Expansion Neutral Recessionary Source: Bloomberg, RBC Wealth Management 13

14 Synchronized Global Growth Backdrop Remains Intact Economic surprises are back on the upswing Economic surprises back on the upswing PMI data firmly in expansion mode Source: Bloomberg, RBC Wealth Management 14

15 Continued (and Healthy) Earnings Growth in 2019 S&P 500 Consensus EPS Source: JP Morgan, Thomson Reuters 15

16 Corporate Balance Sheets Remain Robust Fueling strong buyback momentum Source: JP Morgan, Bloomberg 16

17 Buybacks Not Crowding Out Investment Capital expenditures at record highs Source: FRB, BEA 17

18 Housing Market is in the Mid-Innings of a Recovery The latest reading is still below the long-term average Private Residential Investment as % of GDP Historical Average: 4.64% Jun-18, Mar-67, 3.48 Mar-75, 3.79 Jun-70, 3.88 Sep-82, 3.22 Mar-91, Source: U.S. Bureau of Economic Analysis 18

19 U.S. Economy is Creating Jobs Source: U.S. Bureau of Labor Statistics 19

20 Consumer Balance Sheets are Strong U.S. Household Debt to Disposable Income Composition of Consumer Debt Since 2002, trillion $ Mortgage HE Revolving Auto Loan Credit Card Student Loan Other Household Debt/Disposable Income x 1.15x 1.10x 1.05x 1.00x 0.95x 0.86x 0.90x 0.85x 0.80x Source: New York Federal Reserve 20

21 Trade risk fading but Canada-specific challenges remain

22 Canadian Market Relative Performance The S&P/TSX has dramatically underperformed the S&P 500 TSX versus S&P 500 (indexed to 100) Relative sector performance S&P/TSX S&P 500 (USD) S&P 500 (CAD) Benchmark Financials (112%) (50%) 300 Energy (39%) 250 Materials (102%) Industrials Discretionary (110%) 35% 150 Telecom 45% Technology Utilities (184%) (70%) 50 Staples 82% Real Estate 1% Health Care (173%) Source: Bloomberg 22

23 S&P/TSX Historically Cheap Relative to the S&P TSX More Expensive Than S&P TSX Cheaper Than S&P Relative PE: TSX / S&P Year Average 10-Year Average Source: Bloomberg 23

24 TSX Earnings Expected to Exceed S&P 500 in E EPS Growth by Sector 35% 32% S&P/TSX S&P % 26% 25% 25% 20% 19% 15% 10% 5% 16% 7% 8% 10% 13% 12% 12% 13% 13% 10% 9% 7% 6% 12% 4% 9% 13% 10% 0% 1% 0% Resource Sectors S&P/TSX: +23% S&P 500: +20% Non-Resource Sectors S&P/TSX: +11% S&P 500: +9% Source: Bloomberg 24

25 Canadian Household Leverage Below Pre-Crisis U.S. Household leverage (% of disposable income) Source: Statistics Canada, RBC Economics 25

26 But Sensitivity to Higher Rates Has Never Been Higher Mortgage servicing sensitivity to a 1% rate increase (% of disposable income) Source: CREA, RBC Economics 26

27 At a Time When Rates are Inflecting Higher Canadian 5-Year Mortgage Rate (5-Year Change) Source: CMHC, Haver Analytics, RBC Global Asset Management 27

28 Housing Making an Outsized Contribution to GDP Canadian housing share of GDP at highs Source: Haver, RBC Global Asset Management 28

29 Affordability Never More Stretched Source: RPS, Royal LePage, Statistics Canada, Bank of Canada, RBC Economics 29

30 Interest Rates the Recent Driver of Affordability Loss Source: RPS, Royal LePage, Statistics Canada, Bank of Canada, RBC Economics 30

31 National Look at Housing Resale activity has bounced off 2018 lows Post-stress test transition period is over (pull-forward payback new normal) Price gains have similarly bounced with a 2.5% y/y rise for the national benchmark in August RBC Economics sees little risk of a run-up in prices (rising interest rates and affordability issues) Majority of local markets are balanced, including Vancouver and Toronto Source: CREA, RBC Economics 31

32 Structurally Bullish on Crude Oil Market has shifted from oversupply to undersupply Challenged producers (e.g. Iran, Venezuela), limited spare capacity within OPEC, a lack of new investment in long-cycle projects and U.S. bottlenecks will keep supply in check Global economic growth and growing carbon-intensity in emerging markets continues to propel demand Global Oil Supply and Demand Balance Source: RBC Capital Markets 32

33 Bottlenecks Driving Discounts for Canadian Energy Lack of material pipeline relief until 2020 at the earliest Source: RBC Capital Markets 33

34 And Our One Buyer Issue Exacerbates the Issue 8 U.S. refineries process >50% of Cdn. exports U.S. imports of light crude on the decline Source: RBC Capital Markets. EIA, Bloomberg, Company & Government Reports 34

35 Pipeline Capacity Constraints and Crowding Evident Heavy differentials at 5-year high and light discount emerging Canadian heavy oil vs. WTI Canadian light oil vs. WTI Source: RBC Capital Markets, EIA, Bloomberg, Company & Government Reports 35

36 Agreement Reached on the New NAFTA Few surprises and some key wins from Canada s perspective What did Canada give up? - Auto trade: 75% NAFTA content requirements & 40% higher wage zone - Sunset clause: 6-year review followed by potential 10-year sunset - Dairy trade: Quotas to allocate 3.5% of dairy market to U.S. imports - Biologic drugs and de minimis thresholds What did Canada get? - Auto tariffs: Exemption from potential U.S. auto import tariffs - Chapter 19: Dispute resolution mechanism largely left intact 36

37 USMCA Has Not Buoyed Small Business Sentiment Source: RBC Capital Markets, Haver 37

38 Fresh Action Coming to Address Competitiveness? Fiscal update said to address competitiveness challenges Competitiveness Challenges Relative to the U.S. Labour Tougher labour laws in Canada Higher minimum wage Easier unionization Full-time/part-time equivalency Environment Canada in Paris agreement, U.S. out New carbon taxes ramp up over next five years More extensive resource consultation process Regulations U.S. deregulating; Canada regulating Taxes U.S. taxes fell sharply; Canadian taxes have risen Tariffs / Trade Policy U.S. applying tariffs to Canada Trade policy uncertainty hurts Canada more than U.S. Source: RBC Global Asset Management 38

39 We Recommend a Market Weight in Canadian Equities Relative attractiveness of valuation is balanced against domestic risks Under what circumstances could sentiment and relative valuation improve? Trade policy uncertainty resolved without material degradation in terms U.S. growth provides tailwind Job market stays strong and keeps consumers spending Business investment and infrastructure spending pick up the slack Certain overhangs will prove more lasting (e.g. rates impact on consumers, energy transportation and competitiveness challenges) 39

40 Parting shots

41 Silver Lining: U.S. Equities Have Become More Affordable Source: RBC Wealth Management, FactSet 41

42 U.S. on Solid Footing with Low Risk of Recession U.S. Recessionary Indicator Scorecard Signal New York Fed Recession Probability Model - - Bloomberg Recession Probability Model - - Yield Curve - - ISM Manufacturing - - Capacity Utilization - - U.S. Real Policy Rate - - Conference Board LEI - - Expansion Neutral Recessionary Source: Bloomberg, RBC Wealth Management 42

43 Market s Track Record is Pretty Good A closer look at 103 years of S&P 500 total returns Positive Years: 77 Negative Years: Observations 1. Markets deliver positive returns most of the time (~75% of observations) 2. Deep drawdowns (-20% or worse) happen infrequently 3. Conversely years of substantial market gains 20%+ happen with a high degree of regularity (~38% of observations) -50% to - 40% -40% to - 30% -30% to - 20% -20% to - 10% -10% to 0% 0% to 10% 10% to 20% 20% to 30% 30% to 40% 40% to 50% 50% to 60% Source: Bloomberg, RBC Wealth Management 43

44 And is Even Better Outside of Recessions Outsized down years are extremely rare outside of recessions Positive Years: 70 Negative Years: Observations 1. Markets deliver positive returns 86% of the time 2. Drawdowns (-10% or worse) fall from 13 observations to 4 3. Tail-risk events are all but eliminated (two of the remaining four happened during world wars) -50% to -40% -40% to -30% -30% to -20% -20% to -10% -10% to 0% 0% to 10% 10% to 20% 20% to 30% 30% to 40% 40% to 50% 50% to 60% Source: Bloomberg, RBC Wealth Management 44

45 Thank You This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. Registered trademarks of Royal Bank of Canada. Used under licence RBC Dominion Securities Inc. All rights reserved. 45