The underperformance of Canadian equities versus their U.S. counterparts may be coming to an end.
With investor sentiment towards U.S. stocks suggesting excessive optimism and recent comments from the Fed and ECB signaling a less dovish near-term stance, David Doyle of Macquarie Capital Markets thinks global equities may be entering a consolidation phase.
The strategist believes this could bring about a buying opportunity in the resource sector and lead to outperformance of the S&P/TSX composite. He also expects the index to benefit from improving sentiment towards China, emerging markets and the Canadian economy.
Despite fears that a weaker Chinese property market and a reduction in the government’s growth target will lead to a hard landing, Macquarie’s commodities and economics teams aren’t all that concerned. Mr. Doyle said healthy indicators of final demand contradict these pessimistic views, while lower inflation provides room for further policy easing to spur growth.
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“We take compressed relative valuations of emerging markets as an indicator that sentiment towards them is at overly pessimistic levels,” the strategist said. “As underlying demand in China proves stronger in the months ahead, we believe this pessimism will reverse, providing a tailwind for the S&P/TSX.”
The outlook for the Canadian economy, specifically worries that the housing market may be overheating, has also negatively impacted the TSX.
While several forecaster predicted that the Bank of Canada would need to cut interest rates to offset weakness in the economy, Mr. Doyle said this sentiment is showing signs of shifting, indicating more economic optimism. He highlighted the outperformance of financials so far in 2012, as well as the fact that futures markets are now implying rate tightening.
The strategist anticipates the TSX will climb to the 13,250-13,750 range in the second half of 2012, which is down from his previous target of 13,750-14,250. This represents upside of roughly 10-14% from current levels. However, these returns are still greater than his outlook for the S&P 500, which he sees in the 1,450-1,500 range in the second half of the year.
“We have pushed out our targets from midyear due to the possibility of a near-term pullback as markets digest recent signals from the Fed and ECB,” Mr. Doyle said.
The strategist prefers cyclical sectors, with his favourite being oil-weighted energy stocks for their improved exposure to global pricing. Next, he likes gold stocks, which should benefit from a constructive macro backdrop for the commodity.
Next on Mr. Doyle’s list is bank stocks for their earnings growth and multiple expansion. He also likes base metals and bulk commodities due to their exposure to improving growth in China.