Are Canadian Equities worth the risk?Mar 15, 2019

Brexit

Are Canadian equities worth the risk?

The Canadian equity market has performed very well so far this year; up over 12% to the end of February. This return is significantly better than other developed markets, with the MSCI World Index up approximately 7.4% in Canadian dollar terms. The Loonie has helped to drive this, up over 3.5% versus the US Dollar. With the S&P TSX returning to levels we saw last fall, what can we expect from here?

Is this sustainable?

We are keeping our expectations measured and taking a cautious approach as the economic and financial data are mixed. While employment levels hover at cyclical highs, the most recent macroeconomic data released last week show that overall growth is decelerating and was in fact below expectations. This was recognized by the Bank of Canada with their decision to hold their overnight rate at 1.75% and they acknowledged that the economy will be weaker in the first half of this year than projected just a month ago. The fact that growth is slowing should not be all that surprising – this is a theme that we see showing up globally.

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What leading indicators tell us?

Leading economic indicators have been declining for some time and the yield curve is also very flat, which is often a cautionary sign. Canada’s fortunes are still closely linked to those of the US. The Citi Economic Surprise Index shows that data there has been disappointing as well. As fiscal stimulus starts to fade, expectations for growth in the US have also been coming down. Although none of these signals are at recessionary levels, the trend does not portend robust growth.

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Profit margins remain high but could come under pressure in a tighter labour market. Do companies have pricing power? Higher energy costs and any further rise in interest rates could challenge this. Valuations for Canadian equities are still more attractive than in other areas, but valuation is notoriously poor as a tactical indicator.

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Remaining cautious

So, at the margin, we are cautious on Canada and are keeping return expectations low at this point. We believe equity prices are vulnerable to any disappointing news and do not believe taking on excess risk will be rewarded at this time. In fact, we have slightly reduced our risk exposure across the board having added to shorter duration bonds and cash equivalents. With high quality money market instruments like 3-month Bankers Acceptances currently yielding more than the 10-year Government of Canada bond, it is difficult to justify taking on higher risk in the bond market either.

Ian Riach’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.