Canadian stocks could be tops: CIBC

Canadian investors hoping to recover some of the lost ground in their portfolios should look no further than their own backyard, according to a report from CIBC World Markets. Canadian equities are likely the best bet for superior returns.

“A diversified portfolio is always wise, but in terms of allocations for Canadian equity investors, it may well be that there’s no place like home,” says Avery Shenfeld, chief economist at CIBC.

The economic factors in Canada’s favour are fairly familiar: relatively low public debt levels; little risk of inflation; and an abundance of energy reserves that isolates the country from geopolitical problems.

“Inflation hasn’t run away to the upside, so the Bank of Canada can chart a more careful course of tightening than what might end up being seen in the emerging market economies,” Shenfeld says. “The nation’s fiscal position, while still in need of growth-slowing belt tightening, isn’t as strained on either a deficit/GDP or net debt/GDP basis as that of the U.S. or Europe.”

Canadian corporate earnings are also proving to be quite robust, with leading economic indicators suggesting there is still room for momentum to grow.

The bank recently developed a Leading Indicator of TSX Earnings index, which takes nine separate data points into consideration in predicting earnings growth. While the reading is below its pre-recession highs, it suggests yearly earnings growth of 20% to 25%.

“While stocks are by no means as cheap as earlier, above-trend earnings growth should continue to provide the market with some support,” says Peter Buchanan, senior economist at CIBC.

He says three quarters of the historical returns on the TSX are derived from earnings growth, with the remainder being influenced by interest rates and other economic factors.

Given the weight of the commodities sectors on the TSX, the overall market is heavily reliant on international growth. So even if inflation does become entrenched in Asia, or political turmoil drags on in the Middle East, the Canadian market should still benefit.

Shenfeld predicts global growth will slow by 1% in 2011 as officials in the emerging markets tighten monetary policy. The resulting drop in economic activity should moderate the rising price of oil.

“We expect prices to fall by $10-15 a barrel when the tensions in Libya eventually ease, leading investors to refocus on fundamentals,” he says. “But the recent spike could persist longer than expected if incoming regimes prove hostile or unstable, or if violence spreads to more significant oil producers.”