Because of last year’s market strength, Canadian valuations are now above long-term averages, says Craig Jerusalim, portfolio manager for CIBC Asset Management and co-manager of the Renaissance Diversified Income Fund.
As a result, “the focus [for 2017] needs to be on earnings growth, as we are unlikely to experience further multiple expansion. In fact, it is more likely that we experience modest multiple compression back towards longer-term averages,” he says.
“2016 was a surprising year on many fronts,” Jerusalim explains. “We started the year with a 10% correction and, [in] a complete about-face, an impressive 33% bull run followed.” Canadian growth was spurred by an upturn in commodity prices and increased global growth, he adds, as well as “pent-up demand from an extended period of sluggishness post the financial crisis.”
Canada was also boosted by the results of the U.S. election, says Jerusalim. At the end of 2016, “We saw multiples expanding from about 19 times trailing earnings to about 22 times to close out the year. [That] led to the TSX delivering its best results since the end of the financial crisis.”
Where can you find growth?
Despite anticipated slower growth in 2017, the Canadian dollar could lend support. Says Jerusalim: “The weaker CAD should translate into higher foreign earnings once translated back into Canadian dollars.” The bad news, however, “is that we are unlikely to see the magnitude change in commodity prices that boosted the resource-heavy TSX in 2016.”
As a result, fundamentals will be an important focus this year. “In 2016, sector correlations spiked. [This year] should see a return to fundamental, bottom-up stock picking, which should benefit active managers supported by strong research teams. That should come at the expense of the more passive ETF approach.”
The sectors that are best positioned to outperform are those for which analysts have the lowest expectations, he continues. But winners may be hard to find, “with consensus expectations calling for 23% growth year-over-year and a forward earnings multiple close to 17-times. It’ll be difficult to see expectations surpassed anywhere.”
For instance, to exceed expectations, “energy would need to see further actions taken by OPEC to offset North American production growth, [while] the materials sector would need to see global growth re-accelerate, specifically in emerging Asian countries,” says Jerusalim.
As it stands, OPEC and other producers have agreed to cut output by almost 1.8 million barrels per day during the first half of 2017 despite rising U.S. production, and are so far sticking to the pact. Meanwhile, experts are calling for slower growth in China, but one report suggests emerging market economies (including China, India and Indonesia) are going to become bigger players by 2050.
Jerusalim adds, “Financials would need to be supported by further deregulation and rising interest rates.”
Currently, Jerusalim favours names like Granite REIT, CN Rail and CGI. He suggests investors continue to look for the following when analyzing markets:
- companies that have the strong balance sheets as well as the flexibility and optionality to react to changing conditions;
- companies that have consistent competitive advantages that will allow for profitability and high margins; and
- companies with management teams that have a successful track record of execution and growth.