Canadian equity markets have weathered the roughest storm in their cyclical journey. With the only way for them to go being up, investors who jumped the ship in 2008 may be happy to note that the coast now is clear.
This sums up the sentiment expressed by leading investment experts during BMO’s recent quarterly CIO media conference call.
“We are presently recommending an overweight allocation to equities,” said Michael Herring, investment strategist and managing director, BMO Nesbitt Burns. “We view the market on our gauge as being right around fair value and that is something that distinguishes it from some of the competing asset classes.”
The equity market has spent a few months correcting and consolidation the gains from the March 2009 lows – between late April and mid-July – and since then there’s been a cracking rally that has taken it back to the levels it was at in May, he said.
The two key components that reflect the direction of the market are valuation and sentiment. Between March 2009 and now, the market has gone from deep undervaluation for equities since the early 1980s to about fair value. “Our basic premise is that cyclical bull markets do not end at fair value,” said Herring. “Our expectation is that the market will move from deep undervaluation through fair value and on to overvaluation before the cyclical bull market ends.”
The way things stand at the moment, the equity market is poised for a good upside. “On the valuation front, all the gauges we look at show the market at about fair value,” said Herring.
Paul Taylor, chief investment officer, BMO Harris Private Banking, agrees provided there’s a stable credit environment in Greece and Ireland. “If that’s the case then there’s no doubt the valuations are quite reasonable and we should get year-over-year earnings growth for the Canadian equity market.”
Despite a promising prospect, however, the picture of sentiment shows there doesn’t seem to be a strong wish-you-were-here craving among investors. At least 1,500 Canadians investors in a recent survey reflected a rather gaping disconnect between outlook and investment.
The survey, said Herring, tried to gauge investors’ attitude towards the market, particularly how they were feeling about the equity market. “What we found was that 62% of respondents were either somewhat or very optimistic in their outlook for the equity markets and yet only 13% were somewhat or much more likely to invest in stock.”
The sentiment picture is quite consistent with investment patterns in the US and Canadian markets since late 2008 both of which have seen fairly steady net redemptions of equity mutual funds and massive purchases of bond funds. “Since December 2008 we have seen roughly $230 billion of net outflows from equity mutual funds and more than $550 billion of flows into bond mutual funds,” said Herring.
This in spite of the fact that for much of the period of time since December 2008 the equity markets have been in rally mode. It is not just the individual investor and mutual funds that have been talking with their money, but pension boards as well who “have increased their allocations to investments with much worse prospective rates of return than the equity markets.”
“We think there’s significant potential for upside from here just because the markets have managed a rally roughly 80% with two big players not involved,” said Herring.
Canada is witnessing a valuation pattern similar to that of the U.S. Canadian stocks are offering yields that exceed those of Canada bonds, said Taylor adding that given this scenario “the alternative – cash and bonds – is a fairly easy hurdle to get by.”
“We’re cautiously optimistic, we believe returns from equities will be fairly modest” but on a relative basis versus cash and bonds, returns “could be that much stronger.”