By JENNIFER DOWTY
Thursday, July 18, 2019
While the S&P/TSX Composite Index staged a major comeback at the start of 2019 and is up approximately 15 per cent year-to-date, it's relatively unchanged from where it was one year ago. Since the beginning of 2018, the S&P/ TSX Index has repeatedly stalled around the mid-16,000 level. In the current environment, active portfolio management including sector rotation, stock selection and country and industry exposure diversification have become increasingly important for investors to employ in order achieve attractive returns.
In a recent interview with The Globe and Mail, Kurt Reiman, BlackRock's chief investment strategist for Canada, shared his market expectations and thoughts on how investors may want to position their portfolios for the second half of 2019. Here are excerpts, with an expanded version available to subscribers online at tgam.ca/inside-themarket.
With North American equity markets at or near record levels, what is your outlook for the months ahead?
Equities still have more upside from here. Earnings estimates for the next 12 months seem pretty reasonable, maybe they are a little bit optimistic but not too bad.
Canadian earnings have been holding up remarkably well relative to other regional markets.
When you look at measures of valuation, the market doesn't appear overly stretched.
When you are in this environment where geopolitical and especially trade tensions are the predominant driver of the macro environment, it makes sense to alter your geographic equity allocations to markets that are less affected and away from markets that are more affected. For example, we retain our overweight in the U.S. and that is reflecting that fact that U.S. economic growth, even though it's slowing, is the best in the developed world. The U.S. equity market is heavily weighted towards sectors that have what I would call structural growth dynamics, like technology and health care. The U.S. equity market over all has shown that it is able to consistently deliver a higher return on equity and valuations are not stretched.
We have reduced our exposure to emerging markets, we have brought that down from an overweight to neutral, and we have lowered our allocation to Japanese equities from a neutral to underweight and we have brought Asia, ex-Japan, also from a neutral to an underweight.
Also, we reiterate our preference for taking a minimum-volatility approach, or to have a minimum-volatility screen for our equities to keep the portfolio from not moving around too much. For Canadian investors, if they were to take a minimumvolatility approach, they would end up diminishing the share of their portfolio that is focused on financial, energy and materials, some of these cyclical and valueoriented parts of the market, and [taking] higher allocations in some of the more defensive sectors. We think that is a reasonable approach because value-oriented companies don't typically perform well during periods when investors are thinking that either the economy is going to be slowing or heading into a recession. In fact, that's when value performs the worst. Value performs the best when you are coming out of a recession, when you are starting to recover.
Importantly is to stress that for the second half of the year, I don't think returns will be as good as they were in the first half. I still think investors are going to be rewarded for gaining exposures to equities, but it's really important [to be tactical] about which markets and the weightings.
Should investors be taking profits ahead of second-quarter earnings announcements as management outlooks may be cautious?
No, I don't think I would be necessarily taking profits here. I would still be looking to investing with an eye towards the next six to 12 months. Our message is that protectionism and geopolitics are going to drive macro outcomes and that's going to potentially drive some volatility in markets but because we have central bank monetary policy support, this is likely extending the economic cycle relative to what it might otherwise be.
Earnings growth is holding up and the markets are not particularly expensive here. I would be favouring holding an overweight to equities.
One idea - it's been a great year for bond investors, 6 per cent or so returns in government bonds and maybe 8-per-cent returns if you went into investment-grade or high-yield bonds.
Those are great numbers for a bond investor. Where I may be thinking about taking a little bit of risk out of the portfolio is more on the long end of the government bond market where yields are quite low. For investors who may be making more changes to their portfolios than others, something to think about is shortening the maturity profile of their government bond holdings and considering if they want to take the proceeds and raise cash or if they need income, investing in investmentgrade bonds. If they are willing to take risk, perhaps even looking into emerging market debt.
From a valuation perspective, how much potential upside do North American stock markets have?
When I have said the equity market looks fair, I have been speaking about the U.S., which is effectively in line with its five-year average [on a price-to-12-month forward earnings basis]. Canada, on the other hand, is almost 10 per cent below its five-year average. The energy [sector] is 50 per cent below its five-year average.
Returns over the next year or so are not necessarily going to come from multiple expansion but rather from earnings and dividend growth. Looking out over the next year, earnings growth is [forecast to be] in the mid- to high single digits for both the U.S. and Canada.
Are the sector laggards, such as energy that has lagged the performance of the S&P/TSX composite index year-to-date, value traps?
Broadly speaking, value managers have just been through an extended period of underperformance. I think it's probably safe to say that, with oil prices at the higher end of their recent range but probably range bound, energy represents something of an opportunity - but I would probably be selective here. I would be careful with some of the companies that are just in the business of production and maybe think more about the companies that are involved in the pipeline or mid-stream energy companies or companies that are integrated and have broader operations. I think there are opportunities within energy. There are always opportunities within the value space.
This interview has been condensed and edited