EQUITIES COMMENT - " TSX Makes Record High - Are More Advances Ahead?"

A synchronized global economic expansion is driving growth in corporate profits and in turn propelling world stock markets to record highs. After years of policy stimulus, 2017 global growth should clock in at the strongest since 2011. There’s more good news; leading economic indicators suggest the expansion should continue in 2018 with no recession on the horizon. Now for the bad news; monetary policy stimulus is being dialed down however, as long as central banks do not raise rates aggressively, growth should remain solid. U.S. tax reform provides further support to the positive outlook.

The TSX Composite had a strong finish to 2017 with a total return of 4.5% (includes dividends) during the final quarter. The index was powered by two of the big three sectors--Financials (strong earnings results for the banks) and Materials (fertilizer and base metal mining stocks rose as commodity prices strengthened). Health Care was also a big contributor (the outlook for debt heavy Valeant has improved with asset sales). The Energy sector was actually down .2% during the quarter despite a 17% increase in the price of light crude oil. Canadian energy stocks were held back by pipeline bottlenecks for heavy oil (shut down of TransCanada pipeline to repair leak). This had a negative impact on volumes and heavy crude prices. For the year, all sectors except Energy had positive returns (see accompanying chart) and when dividends are included, results were in line with the long term rate of return for the stock market (7-9%).

These returns pale in comparison to the recent advances in marijuana stocks and bitcoin. Over the years, we have analyzed high risk, speculative “investments” like these and have generally concluded that the risks outweigh the potential returns. Some of the risks investors are exposed to that are not present with the large cap, blue chip stocks we favour are liquidity (limited buyers and sellers-may have to sell at much lower than market price), limited track record (operating a business during a downturn is much more difficult than in the good times), transparency (fewer reporting requirements limits information to value the investment), extremely uncertain or limited revenues, negative cash flow and extensive equity financing. One barometer we look at for measuring the performance of high risk/alternative assets is the hedge fund industry; the median annual return for hedge funds has been below the U.S. S&P 500 stock index in many years.

The TSX set a record high in the fourth quarter and we expect additional milestones to be achieved this year. Our target is 17,000. This assumes a slightly lower valuation (due to modestly higher interest rates) and robust earnings growth supported by an expanding global economy.

TSX Composite Index

In our view, the wildcard for the TSX in 2018 will be the performance of the Energy group. We are assuming a modest rebound in the sector however, if oil prices surprise to the upside, our TSX target could be surpassed. There are a number of factors at play.

POSITIVES:

Oil inventories continue to be drawn down as strong global growth is boosting demand.
Adherence to a production sharing agreement among OPEC and non-OPEC producers is restraining supply.
Even at $60, many companies and countries that rely on oil revenues are not earning enough to generate an adequate return on capital or finance government spending
Reduced pipeline constraints should allow Canadian heavy oil prices to rise.
Increased turmoil in the Middle East could result in a potential supply disruption.

NEGATIVES: