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In many cases, record highs are cause for celebration – just not when it comes to investing.

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“As a professional investor, I am a professional worrier,” says Colum McKinley, vice-president of Canadian equities at CIBC Asset Management. “When I look at individual stocks or markets, I’m always thinking about reversion to the mean.”

Given that the broad market is trading at valuations above the historical long-term average, “I worry about the downside risk that can exist in a market today,” says McKinley, who’s one of the managers of the Renaissance Canadian Core Value fund. (On Nov. 7 the TSX opened on a high note, with the index up 16.5 points, or 0.1%, but that gain was reversed by Wednesday morning.)

To determine whether or not his worrying is justified, he thinks about what could catalyze a downturn for a given security.

“The backdrop for equities today actually remains quite supportive; that’s what we’re seeing from corporate results,” he says. “Economic data continues to show an environment where earnings outlook and earnings prospects are improving.”

This week marks the beginning of Canada’s Q3 earnings season, with nearly 100 listed firms due to release results.

Read: Can you deliver investors’ return expectations?

On-the-ground discussions with firms also reflect a positive outlook.

“When we sit down and […] speak to the CEO or managers of key divisions, they have a cautious level of optimism in their commentary about their business as they look out over the next 12 to 18 months,” says McKinley.

But he doesn’t take those leaders at their word. “We’re monitoring very closely […] signs that the earnings trend is going to start to deteriorate [or] that that outlook that we’re seeing and hearing from managers isn’t as rosy as the market is pricing [in],” he explains.

Market analysis

So far, he’s also not panicking about the country’s two main sectors: financials and energy.

Despite fears about the Canadian economy, “we have seen the Canadian banks deliver consistent, very strong results,” in the form of mid-single-digit earnings growth, says McKinley.

“If you look at the valuation of any of the Canadian banks, yes, the banks’ stock prices are at record highs,” he says. “But the valuations for many of the Canadian banks are now just getting back to the average valuation over the last five years.” He adds they will likely offer continued dividend growth.

McKinley notes, “On [a] one-year forward basis [and] price-to-earnings multiple basis, Canadian banks usually trade between 11.5x [and] 12x. While the stock prices have risen to record highs, the underlying earnings of the businesses have also grown at attractive levels. As a result, valuations using P/E multiples remains attractive.” 

Read: Banks’ predictions for the next BoC rate hike

As for the energy sector, he’s cautiously optimistic – especially since energy stocks are still below their long-term average valuations.

“We’re working through a supply and demand imbalance, and with the assistance of the work the OPEC has done to curtail supply and in an environment where demand has continued to remain quite robust, we are seeing signs that […] we’re moving back to a more balanced market,” says McKinley.

OPEC’s October market report shows that in 2018, world oil demand is anticipated to grow by 1.4 million barrels per day – revised up from 1.35 million in the previous month’s report. Further, the OPEC Reference Basket rose to $53.44/barrel in September, its highest value since July 2015. For the long term, OPEC expects global oil demand to steadily lessen by 2040 but says fossil fuels will remain a key energy source.

Read: Demand for oil to drop over next 2 decades : OPEC

Says McKinley, “We […] see further upside as long as we continue to see a supportive commodity price environment.”

The main message? “Even in an environment where stocks have moved to record highs, the market is never even-handed in how it distributes those returns.”

Read: Best Canadian commodity picks

Originally published on Advisor.ca
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