RBC Dominion Securities The Harbour Group of RBC Dominion Securities
Canadian Economy Surprises To The Upside Canada s economy is posting world-beating numbers as we lap the wildfire-related weakness of 2016. The U.S. economy is also picking up steam after a typical slow start to the year. Geopolitical risk has resurfaced, with North Korea making headlines. Markets tend to ignore these threats until they are inevitable, and usually bottom as the event occurs. While a stronger loonie is a good thing from a purchasing power perspective, it also dampens returns on foreign securities. The U.S. market has led Canada in 2017, and valuation differentials are wide - reversion to the mean could bring on meaningful gains for the TSX. Banks are one of many TSX sectors that look cheap compared to their U.S. counterparts. Source: RBC Wealth Management 2
Canada Leading The Global Growth Parade For the first time in years, economists expect global growth to accelerate across the U.S., Eurozone and Japan, and Canada is leading the G7. All 46 countries monitored by the OECD are on track to grow this year, the first time this has happened since 2007. 3
Manufacturing Continues to Impress The ISM Manufacturing Index recently hit a six year high after stumbling in 2015. Manufacturing data is a strong leading indicator for economic activity, corporate profits, and ultimately dividends and stock prices. 4
Metals Prices On The Move Base metals prices have accelerated to the upside in recent months, suggesting strong demand from industrial users. Over the long term, metals and crude oil have similar trends, indicating the problems in the oil market are due to oversupply as opposed to demand. 5
Inflation Yet To Emerge As A Concern After a gasoline-fueled run up in inflation earlier this year, overall price gains have faded as the base effects of low oil prices wears off. Inflation is nowhere near levels that worry central bankers, and the rate increases we have seen are in the vein of removing accommodation as opposed to reigning in an overheated economy. 6
Geopolitical Risks Back To The Forefront 7
TSX Not Reflecting Resurgent Canadian Growth The TSX outperformed in 2016 as the Canadian economy was suffering from the oil bust and Alberta wildfires. Now that Canadian economic growth is outperforming, the TSX is frustratingly lagging every other developed market. One could argue that the TSX s 2016 outperformance price some of this in, but it doesn t change the fact that the TSX is a laggard this year. Global Equity Performance Heat Map Since 2000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Dow Jones -6.2% -7.1% -16.8% 25.3% 3.1% -0.6% 16.3% 6.4% -33.8% 18.8% 11.0% 5.5% 7.3% 26.5% 7.5% -2.2% 13.4% 12.0% S&P 500-10.1% -13.0% -23.4% 26.4% 9.0% 3.0% 13.6% 3.5% -38.5% 23.5% 12.8% 0.0% 13.4% 29.6% 11.4% -0.7% 9.5% 11.4% NASDAQ -39.3% -21.1% -31.5% 50.0% 8.6% 1.4% 9.5% 9.8% -40.5% 43.9% 16.9% -1.8% 15.9% 38.3% 13.4% 5.7% 7.5% 19.7% TSX 6.2% -13.9% -14.0% 24.3% 12.5% 21.9% 14.5% 7.2% -35.0% 30.7% 14.4% -11.1% 4.0% 9.6% 7.4% -11.1% 17.5% -1.0% UK FTSE -10.2% -16.2% -24.5% 13.6% 7.5% 16.7% 10.7% 3.8% -31.3% 22.1% 9.0% -5.6% 5.8% 14.4% -2.7% -4.9% 14.4% 3.6% France CAC 40-0.5% -22.0% -33.7% 16.1% 7.4% 23.4% 17.5% 1.3% -42.7% 22.3% -3.3% -17.0% 15.2% 18.0% -0.5% 8.5% 4.9% 7.1% Germany DAX -7.5% -19.8% -43.9% 37.1% 7.3% 27.1% 22.0% 22.3% -40.4% 23.8% 16.1% -14.7% 29.1% 25.5% 2.7% 9.6% 6.9% 9.1% Swiss Market 7.5% -21.1% -27.8% 18.5% 3.7% 33.2% 15.8% -3.4% -34.8% 18.3% -1.7% -7.8% 14.9% 20.2% 9.5% -1.8% -6.8% 10.1% Japan Nikkei -27.2% -23.5% -18.6% 24.5% 7.6% 40.2% 6.9% -11.1% -42.1% 19.0% -3.0% -17.3% 22.9% 56.7% 7.1% 9.1% 0.4% 3.5% Australia 2.8% 6.7% -12.1% 9.7% 22.8% 17.6% 19.0% 11.8% -41.3% 30.8% -2.6% -14.5% 14.6% 15.1% 1.1% -2.1% 7.0% 1.4% Source: The Harbour Group, Bloomberg 8
Currency Weighs on Foreign Returns The S&P 500 s outperformance in 2017 has been subdued by the strong performance of the Canadian dollar, but it is still outpacing the TSX slightly. Either a weaker Canadian dollar or mean reversion in the TSX would bode well for portfolio performance in the final months of 2017. 9
The Silver Lining? Canadians Wealthier On A Global Basis After years of losing purchasing power on a global basis, the rise in the CAD has made Canadians wealthier when buying assets abroad. This has also been reflected in the TSX s return when measured in U.S. dollars, which isn t too far off the S&P 500 s 2017 performance. 10
TSX Still Looks Cheap The S&P 500 s price to book ratio is currently 74% higher than the TSX s, the highest it has been since the tech bubble was bursting in 2001. As seen in the chart, these trends can persist for some time, but it is hard to argue that the TSX isn t due for some reversion to the mean. TSX Price To Book and S&P 500 Price To Book 11
And Canadian Banks Are Currently Attractive Despite consistently posting solid earnings and dividend growth, Canadian banks have not put up the sort of returns we have become accustomed to. The relative valuation of the Canadian banks is near a seven-year low versus U.S. banks. 12
In Summary The soft performance of the TSX belies the strength being exhibited by the Canadian economy. While Canada leads, signs abound that the global economy is firing on all cylinders. The TSX has underperformed year to date, but we believe this cyclical weakness has the potential to reverse as valuations favour the TSX over the S&P 500. On a price to book basis, the TSX is the cheapest it has been since 2001, and Canadian banks are now trading at a discount to U.S. banks, a rare occurrence in recent years. The Canadian dollar s strength has been in part due to better fundamentals but appears to have run quite far in a short period of time. While the turnaround in the loonie is weighing on the return on foreign securities, the fact is we are now wealthier on a global basis which is a good news story. 13
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