Highlights May 215 Global equities rose to another all-time high in April. Encouragingly, the gains have been widespread. All major regions show positive returns so far in 215. Markets where central banks are applying quantitative easing the euro zone and Japan are still showing double-digit gains year to date (in local currency). Emerging markets have taken a commanding lead early in Q2 with a month-to-date return of 7.1%. Going into the Q1 earnings season, there was much apprehension of drag from USD strength. With just over 4% of companies now reporting, the news is encouraging. All of the main sectors are beating earnings expectations. After a difficult beginning of the year, the S&P/TSX has been doing well in recent weeks. A month into Q2, the index has advanced 3.4% on the strength of sizeable gains for energy and bank stocks, up 8.6% and 5.1% respectively. Our asset mix view is unchanged this month. We remain comfortable with our recommendation to overweight equities relative to our benchmark, with a slight preference for non-u.s. assets to reflect our view that the U.S. dollar is likely to stabilize somewhat. Our year-end targets are 16,2 for the S&P/TSX and 2,22 for the S&P 5. Our sector rotation is also unchanged this month with its slight preference for non-interest-sensitive sectors. We are staying with our overweight recommendation for the Canadian Energy sector. A rise in energy prices due to the combined effect of U.S. production cutbacks and a tamer greenback could reignite interest in this sector. Stéfane Marion stefane.marion@nbc.ca Matthieu Arseneau matthieu.arseneau@nbc.ca
Another record Global equities rose to another all-time high in April. Encouragingly, the gains have been widespread. All major regions show positive returns so far in 215 (table). Markets where central banks are applying quantitative easing the euro zone and Japan are still showing double-digit gains year to date (in local currency). MSCI indexes: Price performance Month to date Quarter to date Year to date MSCI AC World 3.1 3.1 7.7 MSCI World 2.7 2.7 7.2 MSCI USA 2.4 2.4 3.3 MSCI Canada 3.5 3.5 5.8 MSCI Europe 2.3 2.3 13.6 MSCI Pacific ex Jp 2.9 2.9 1. MSCI Japan 5.1 5.1 15.1 MSCI EM 7.1 7.1 12. MSCI EM EMEA 5.4 5.4 1.6 MSCI EM Latin America 7.3 7.3 7.8 MSCI EM Asia 7.5 7.5 13.4 4/24/215 Emerging markets have taken a commanding lead early in Q2 with a month-to-date return of 7.1%. Some of this lift can be traced to the recent pause in U.S.-dollar appreciation, which has helped stabilize commodity prices and emerging-market credit spreads good news indeed for the global economy. World: A pause in USD appreciation is good news Trade-weighted U.S. dollar index (vs. 23 countries) BofA ML Asia emerging-market corporate bond spreads to U.S. Treasuries 12 Index 1, Basis points 118 9 116 114 8 112 7 11 18 6 16 5 14 12 4 3 98 96 2 94 92 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 27 28 29 21 211 212 213 214 215 2 22 24 26 28 21 212 214 NBF Economics and Strategy (data via Federal Reserve) While it is true that most of the equity market gains are still driven by P/E expansion (chart), current valuations remain supported by very low interest rates and prospects of stronger earnings. World: Equity valuation since 1995 Ratio of price to 12-month forward earnings 26 24 22 2 18 16 14 12 1 8 Ratio 6 1996 1998 2 22 24 26 28 21 212 214 The trailing earnings of the MSCI AC index, after tumbling about 1% since the third quarter of 214, appear to be levelling off (chart). World: Profits are stabilizing MSCI AC trailing earnings 29.8 29.6 29.4 29.2 29. 28.8 28.6 28.4 28.2 28. 27.8 27.6 27.4 27.2 27. 26.8 26.6 EPS (4-week MA) U.S.: Earnings season MSCI World Emerging Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 213 214 215 Going into the Q1 earnings season, there was much apprehension of drag from USD strength. With just over 4% of companies now reporting, the news is encouraging. All of the main sectors are beating earnings expectations. For the S&P 5 the beat factor is 6.7%, versus a long-term average of 2%. 2
U.S.: Q1 earnings not so bad Sales Surprise Earnings Surprise Industry (ICB) Reported Positive Inline Negative % (y/y) Positive Inline Negative % (y/y) All Securities 21 / 5 13 15 -.9% 16 2 48 6.7% > Oil & Gas 11 / 39 6 4-4.5% 9 2 6.5% > Basic Materials 1 / 22 3 6-4.4% 8 2 14.5% > Industrials 38 / 76 17 21-3.2% 26 12 4.1% > Consumer Goods 3 / 63 17 13-1.9% 23 7 3.8% > Health Care 19 / 49 12 7 1.1% 16 3 6.4% > Consumer Services 24 / 72 12 12 -.5% 2 4 6.7% > Telecommunications 2 / 5 2 -.8% 2 5.% > Utilities 3 / 32 1 2-5.6% 3 1.8% > Financials 47 / 91 22 25.6% 34 2 11 9.6% > Technology 26 / 51 13 13 1.3% 19 7 5.6% NBF Economics and Strategy (data via Bloomberg as of April 27, 215) Canada: Positive surprise? After a difficult beginning of the year, the S&P/TSX has been doing well in recent weeks. A month into Q2, the index has advanced 3.4% on the strength of sizeable gains for energy and bank stocks, up 8.6% and 5.1% respectively. Year to date, the composite index is up 5.3%, with Energy stocks up 6.5% (banks are still down.2% on the year). Our decision to overweight Energy last December is paying off. S&P/TSX Composite: Price performance Though sales have been softer than expected, we would attribute much of the weakness to very harsh weather during the quarter. The U.S. leading economic indicator was still about 6% up from a year earlier in Q1 and we see little reason to fear a protracted slowdown of the U.S. economy, especially now that USD appreciation is unwinding. U.S.: Leading indicators still favourable Leading economic indicator (total and total ex financial components) 12 8 4-4 -8-12 -16-2 % y/y, quarterly data -24 2 22 24 26 28 21 212 214 Total LEI LEI ex financial components True, a Greek default or a Grexit could create new uncertainty and renewed USD strength, combined this time around with tightening of global credit markets. At this juncture, however, we still think Greece will want to avoid a move that could damage its economy irreparably. Month to date Quarter to date Year to date S&P TSX 3.4 3.4 5.3 ENERGY 8.6 8.6 6.5 IT 6.2 6.2 15.2 FINANCIALS 3.4 3.4 2.2 BANKS 5.1 5.1 -.2 UTILITIES 2.5 2.5 5. TELECOM 2.2 2.2 1.3 MATERIALS 1.9 1.9 4.8 HEALTH CARE 1.5 1.5 47.2 CONS. STAP. -.4 -.4 2.6 INDUSTRIALS -.9 -.9.2 CONS. DISC. -1.5-1.5 4. 4/24/215 After the recent appreciation of the CAD, the total return of the S&P/TSX so far in Q2 is second only to that of emerging-market equities (+4.7%) among asset classes (chart). Major asset classes performance in Q2 QTD total return (% in CAD) S&P 5 Composite FTSE Uni 3D T Bill MSCI EAFE S&P TSX MSCI Emerging 2. 1.. 1. 2. 3. 4. 5. 6. 3
We see continuing upside in the S&P/TSX. First, Q1 earnings expectations are extremely depressed the analyst consensus sees earnings declines of 2% from a year earlier for the composite index and 84% for the Energy sector (table). For the S&P/TSX ex Energy the view is less gloomy earnings growth of 6.3%, with seven of the 1 sectors expected to report net income up from a year earlier. Net Income Growth (%, Q t /Q t-4 ) : S&P TSX and Sector Indexes Reported Net Income Q1 214 ($M) Blended Estimate of Net Income Q1 215 ($M) % Change S&P/TSX 2788 2166-2. S&P/TSX EX. FINANCIALS 16157 1175-37. S&P/TSX EX. ENERGY 1926 2414 6.3 S&P/TSX EX. FIN. & ENE. 8275 8929 7.9 S&P/TSX CONS DISCRET IDX 1542 1635 6. S&P/TSX CONS STAPLES IDX 77 135 34.4 S&P/TSX ENERGY INDEX 7882 1246-84.2 S&P/TSX FINANCIALS INDEX 1931 11485 5.1 S&P/TSX BANKS INDEX 8239 8442 2.5 S&P/TSX HEALTH CARE IDX 693 923 33.1 S&P/TSX INDUSTRIALS IDX 1332 1838 38. S&P/TSX INFO TECH INDEX 45 57 26.8 S&P/TSX MATERIALS INDEX 1753 1233-29.7 S&P/TSX TELECOM SERV IDX 1393 1423 2.2 S&P/TSX UTILITIES INDEX 343 272-2.6 Source: Bloomberg NBF Economics & Strategy (data via Bloomberg) Second, we think there is room for upside surprise from Energy in particular in the coming months. Oil prices have rebounded significantly in recent weeks. Western Canadian Select (WCS), which accounts for about 55% of Canadian oil production, is up about 18% from the beginning of the year, versus a rise of 4.6% for West Texas Intermediate (35% of Canadian output) and 15.4% for Brent (all in USD). We said last month that the future direction of oil prices was more likely to be dictated by supply than by demand. Data from the U.S. Energy Information Administration (EIA) indicates that the plunge in the number of oil rigs over the last 2 weeks is finally starting to crimp U.S. crude output. As the next chart shows, production from new wells is no longer offsetting the ever-rising depletion rate of existing wells. As a result, the EIA now forecasts a decline of 57, barrels a day in U.S. crude output in May. As the chart shows, that would be the second drop in a row and the biggest in more than eight years. U.S.: Crude output expected to drop the most in 8 years plus 45 Thousands of barrels/ day 4 35 3 25 2 15 5 Production from new wells vs. change in legacy production (depletion rate) Production from new wells is no longer keeping up with depletion of existing wells Depletion rate 27 28 29 21 211 212 213 214 215 NBF Economics and Strategy (data via EIA) 16 Thousands of barrels / day Output from 14 new wells 12-2 Output is set to drop the most in -4 more than 8 years -6 27 28 29 21 211 212 213 214 215 Such a development would have major ramifications for Canadian monetary policy (no need for rate cuts) and the CAD (potential appreciation). Outside Energy as well, things appear to be less bad than expected for Canada. Core inflation is turning out to be stickier and retail sales are proving much stronger, as is the housing market. Alberta s current woes are not morphing into full-fledged contagion to the rest of the country. For Canadian equities, that leaves the great white short Episode II (a second attempt by foreigners to short Canadian banks and currency - chart) unrewarding to investors positioned for a doomsday scenario. For Financials, earnings revisions have even turned positive over the past month (table). Though a day of reckoning may come at some point, we think this is not a 215 story. If we are right, short covering will bring some support to bank and energy stocks and to the CAD. The loonie could extend its stay near the bottom of our 215 target range of 1.2-1.3. Canada: Episode II of the great white short Big six banks: U.S. total short interest outstanding 9 8 7 6 5 Millions of common shares 8 6 4 2 Monthly change in U.S. crude production 4 3 2 1 26 27 28 29 21 211 212 213 214 215 4
Canada: Perspective on earnings revisions Change in 12-month forward S&P/TSX earnings 1-month change 3-month change 1 year historical average 3 month diffusion 1 year historical average S&P TSX -.6-1.7 -.6 31% 43% ENERGY -4.6-53.6-1.8 29% 42% MATERIALS -6.1-19.1-1.1 16% 43% INDUSTRIALS -.1-5.2 -.5 35% 43% CONS. DISC. -1.2-3.5 -.6 2% 45% CONS. STAP. -.2-2.8 -.3 33% 44% HEALTH CARE 6.6 9.7.1 5% 41% FINANCIALS.4 -.5 -.3 56% 47% IT.7 1.8-1.2 5% 5% TELECOM -.2 -.9 -.1 25% 45% UTILITIES -1. -2.9 -.4 6% 43% 4/24/215 Stimulus in China The outlook for commodity prices has been enhanced by China s efforts to rekindle economic growth. Seeing real GDP growth soften to a six-year low of 7% in Q1, Beijing moved to take out insurance against further weakness by reducing the reserve requirements of large commercial banks to 18.5% as of April 2. As the chart below shows, there is plenty of room for more monetary easing in China. China: Monetary easing picks up steam Reserve requirements for large banks 21.6 % 21.2 2.8 2.4 2. 19.6 19.2 18.8 18.4 18. 17.6 17.2 16.8 16.4 16. 15.6 15.2 14.8 28 29 21 211 212 213 214 215 With more easing in the pipeline, some investors are increasingly uneasy about the recent surge in Chinese equities. But though the MSCI China is up 27% year to date and more than 41% from a year ago, its current forward P/E ratio is still in line with its historical average of 12. So market valuation is not extravagant, especially considering the further efforts that Beijing is deploying to keep the Chinese economy growing at about 7% and help profits resume their uptrend. China: Equity valuation since 1996 MSCI China: Ratio of price to 12-month forward earnings 36 Ratio 34 32 3 28 26 24 22 2 18 16 14 Period average 12 1 8 6 4 1996 1998 2 22 24 26 28 21 212 214 There are indications that market participants are becoming more confident about China s resolve to stop its economy from decelerating. Iron ore prices appear to be levelling off for the first time in 215 (chart). China: Iron ore prices stabilizing Spot price of 63.5% iron ore (daily data) 74 USD/ tonne 72 7 68 66 64 62 6 58 56 54 52 5 48 46 5 12 19 26 2 9 16 23 2 9 16 23 3 6 13 2 Jan Feb Mar Apr Asset allocation Our asset mix view is unchanged this month. We remain comfortable with our recommendation to overweight equities relative to our benchmark, with a slight preference for non-u.s. assets to reflect our view that the U.S. dollar is likely to stabilize somewhat. Our year-end targets are 16,2 for the S&P/TSX and 2,22 for the S&P 5. 5
Please note that our benchmark portfolio is being modified this month to align better with that of National Bank Financial Wealth Management. Though the new benchmark means significant changes to our geographic equity allocation, it leaves our overweighted asset classes overweight and our underweighted asset classes underweight. Sector rotation Our sector rotation is unchanged this month, retaining a slight preference for non-interest-sensitive sectors. We are staying with our overweight recommendation for the Canadian Energy sector. A rise in energy prices due to the combined effect of U.S. production cutbacks and a tamer greenback could reignite interest in energy producers. NBF Asset Allocation Benchmark (%) NBF Recommendation (%) Equities Canadian Equities 2 24 U.S. Equities 2 22 Foreign Equities (EAFE) 5 4 Emerging markets 5 8 Fixed Income 45 37 Cash 5 5 Total NBF Economics and Strategy Change (pp) NBF Market Forecast NBF Market Forecast Canada United States Actual Q4 215 (Est.) Actual Q4 215 (Est.) Index Level Apr-24-15 Target Index Level Apr-24-15 Target S&P/TSX 15,48 16,2 S&P 5 2,118 2,22 Assumptions Q4 215 (Est.) Assumptions Q4 215 (Est.) Level: Earnings * 865 9 Level: Earnings * 117 126 Dividend 428 446 Dividend 42 46 PE Trailing (implied) 17.8 18. PE Trailing (implied) 18.1 17.6 Q4 215 (Est.) Q4 215 (Est.) Treasury Bills (91 days).66.63 Treasury Bills (91 days).3.69 1-year Bond Yield 1.44 1.89 1-year Bond Yield 1.92 2.34 * Before extraordinary items, source Thomson * S&P operating earnings, bottom up. NBF Economics and Strategy 6
NBF Fundamental Sector Rotation - May 215 Name (Sector/Industry) Recommendation S&P/TSX weight Energy Overweight 22.3% Energy Equipment & Services Overweight.8% Oil, Gas & Consumable Fuels Overweight 21.4% Materials Market Weight 1.6% Chemicals Underweight 3.1% Containers & Packaging Market Weight.2% Metals & Mining * Market Weight 2.6% Gold Market Weight 4.2% Paper & Forest Products Overweight.5% Industrials Market Weight 8.2% Capital Goods Overweight 1.7% Commercial & Professional Services Underweight.7% Transportation Market Weight 5.8% Consumer Discretionary Underweight 6.3% Automobiles & Components Underweight 1.6% Consumer Durables & Apparel Overweight.6% Consumer Services Underweight.8% Media Market Weight 2.1% Retailing Underweight 1.2% Consumer Staples Underweight 3.6% Food & Staples Retailing Underweight 2.9% Food, Beverage & Tobacco Underweight.6% Health Care Market Weight 5.2% Health Care Equipment & Services Market Weight.8% Pharmaceuticals, Biotechnology & Life Sciences Market Weight 4.4% Financials Market Weight 34.6% Banks Market Weight 21.4% Diversified Financials Market Weight 1.4% Insurance Overweight 6.8% Real Estate Market Weight 5.% Information Technology Overweight 2.5% Software & Services Overweight 2.% Technology Hardware & Equipment Market Weight.6% Telecommunication Services Underweight 4.6% Utilities Underweight 2.2% * Metals & Mining excluding the Gold Sub-Industry. 7
ECONOMICS AND STRATEGY Montreal Office Toronto Office 514-879-2529 416-869-8598 Stéfane Marion Chief Economist & Strategist stefane.marion@nbc.ca Paul-André Pinsonnault Senior Fixed Income Economist paulandre.pinsonnault@nbc.ca Krishen Rangasamy Senior Economist krishen.rangasamy@nbc.ca Marc Pinsonneault Senior Economist marc.pinsonneault@nbc.ca Matthieu Arseneau Senior Economist matthieu.arseneau@nbc.ca Warren Lovely MD, Public Sector Research and Strategy warren.lovely@nbc.ca General: National Bank Financial Markets is a business undertaken by National Bank Financial Inc. ( NBF ), an indirect wholly owned subsidiary of National Bank of Canada, and a division of National Bank of Canada. This research has been produced by NBF. National Bank of Canada is a public company listed on Canadian stock exchanges. The particulars contained herein were obtained from sources which we believe to be reliable but are not guaranteed by us and may be incomplete. 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