TSX run isn’t done, say experts

Last week the TSX hit a record high, leaving many wondering if there’s upside left. There is, if you look in the right places.

Financials and energy

Patrick Blais, senior portfolio manager at Manulife Asset Management, sees opportunity in the two largest sectors: financials and energy.

He likes TD, Bank of Nova Scotia and RBC because of how they’ve grown their divisions over the last decade. “For TD it’s the retail business in the U.S.; for Bank of Nova Scotia it’s their emerging market and Latin American franchises; for RBC it’s the wealth management and capital markets businesses.”

Read: Innovative ways to pick stocks

The energy sector has been strained the last few years because of concerns stemming from takeaway capacity, which refers to infrastructure needed to get oil to target markets. But Blais says these issues are being resolved; TransCanada and Enbridge, for instance, are expanding their pipeline networks.

He adds the impact of recent turmoil in the Middle East may dampen negative sentiment directed toward Canada’s oil sands. “And with the development of LNG [liquefied natural gas], we think there’s definitely a place for Canadian gas.”

Blais focuses on companies generating high netbacks per barrel and strong free cash flow, singling out Canadian Natural Resources and Suncor. He also likes PrairieSky, a royalty company Encana recently went public with at $28 per share (currently over $38).

China’s stronger than you think

Peter Buchanan, senior economist at CIBC World Markets, says China’s prospects bode well for the energy-heavy TSX. Earlier this year, the country boosted infrastructure spending; it also plans 4.5 million new housing units.

“People talk about this dramatic shift in China from infrastructure and investment toward consumer goods. And [they] suggest this is going to lead to a drop off in commodity demand.”

He doesn’t buy that.

“First, we think that shift is going to be fairly gradual; and the other thing is when they’re talking about consumer spending, they’re not often talking about fancy cameras or expensive clothing, but things like housing—and that’s commodity intensive.”

He adds China’s commodity demand is greater than it was a decade ago. “So you’ve got the same kick at 7% or 7.5% GDP growth as you did a decade ago at 12%.”

Shift in energy fortunes

Craig Jerusalim, portfolio manager at CIBC Asset Management, says the energy sector could cause a fundamental and highly positive shift in North America’s economy in the next 10 years.

“You have the equivalent of a Saudi Arabia put in the middle of [the U.S.] with the shale gas revolution,” he says, adding this can mean hundreds of billions of dollars staying within North America rather than going to the Middle East.

“The second derivative of that is a lower [cost] feedstock for the chemicals business, and an improvement in the manufacturing economy. It’s a renaissance in the North American economy.”

Read: Guide investors through bull markets

Blais cautions against certain yield plays in the midstream segment of the energy space. “These are great businesses, but […] we’re seeing a bit of overexuberance in terms of their prospects.”

Instead, he comes back to financials, saying they’re presently underappreciated among those seeking yield.

Firms have been raising capital levels in response to regulatory requirements, and Blais says they should hit their targets by year’s end. “Banks will then be in a position to pay back significantly more capital to shareholders. We think they’ll keep dividends in line with earnings growth, but you’ll benefit from higher share buybacks going forward.”

Tech and demographic stocks

Certain tech stocks also offer opportunities, says Jerusalim. Companies that provide cost-saving services, such as software-as-a-service firms, and those that analyze data from social media platforms such as Twitter and Facebook, could be strong performers.

Buchanan also highlights what he calls demographic stocks. “Canada has one of the fastest-aging populations in the world. That’s often viewed as a challenge, and there’s certainly that dimension to it. But if you’re an investor it presents opportunities.”

He notes the healthcare sector has done well; airlines and other companies involved in travel and leisure also stand to benefit. And because seniors use a higher proportion of wealth management services than other age groups, financials could also get a boost.

Macro environment

Be careful

Some areas of the market may prove less friendly.

Craig Jerusalim, portfolio manager at CIBC Asset Management warns of interest-rate-sensitive names with high valuations, such as REITs. “But I wouldn’t paint all REITs with that brush. Some have better growth opportunities and are less exposed to rising interest rates.”

Read: How to invest in real estate

Paul Taylor, CIO, Asset Allocation at BMO Global Asset Management, says interest rates here and in the U.S. will inevitably rise in the intermediate to long term. But increases will come “at a glacial pace.”

He notes Canada’s 10-year, which is trading around 2.3%, could hit 2.65% by the end of 2014. Twelve months from now, it could reach 2.75% or even 3%.

“And here’s the challenge for Canadian investors,” says Taylor. “If we’re right and rates go from 2.3% to 2.75% to 3%, total returns for bond investors could easily be zero, where interest income is completely offset by capital losses.”

So while Taylor may slightly trim the “dramatic overweight” in his equity allocations, his view is that equities are the place to be. “I heard someone coin this term the other day: TINA — There Is No Alternative to equities.”

Last week’s higher inflation figure of 2.3% also suggests a positive environment for equities, Buchanan notes. “Modest inflation of 2% to 3% has historically been the best for valuations.”

Read: Conservative clients could hedge bonds