Markets around the world dipped yesterday on the back of U.S. uncertainty over whether President Donald Trump will follow through on key economic promises. At market close on May 17, the S&P 500 Index was down 1.82%–its worst daily tumble in eight months–while the S&P/TSX Composite Index was down 1.73%. At open on May 18, both markets were still down but seemed to be slowly recovering.
Market blips like this shouldn’t sway investors. Take Gary Chapman, managing director of Canadian equity at Guardian Capital in Toronto, who’s been bullish on the Canadian stock market since the first quarter of 2012. “We missed calling the bear market in resource stocks, [but] corrections have occurred and, in the grand scheme of things, this has been the right call,” he says.
“The underlying premise of our bullishness [in 2012] was that stocks were inexpensive relative to interest rates,” he explains. There were “benefits and P/E multiple expansions as the memory of the financial crisis faded into the background, and investors recognized that the U.S. economy was healing.”
And he’s sticking to his bullish stance for 2017, despite the effects of short-term headwinds. Reflecting on yesterday’s market activity, Chapman says, “I hold the same view. Trump stuff is sentiment and will not, in my view, factor in [and] impact the economy or the stock market in a lasting way.”
Some of the companies he’s owned over the past five years have benefited from multiple expansions. Those companies have included “Constellation Software, Alimentation Couche-Tard, OpenText and Dollarama, but a great many stocks across the market did benefit from multiple expansions” over this period, says Chapman, whose firm is one of three that manages the Renaissance Canadian Growth Fund.
While he says market dynamics are changing, he remains optimistic on Canadian equities for two reasons:
- Earnings acceleration. “The U.S. economy is accelerating sufficiently, even without a Trump tax cut or infrastructure spending,” says Chapman. “As such, we expect earnings growth to improve after a sluggish few years. This will benefit Canadian companies selling into, operating in, or benefitting from U.S. dollar-denominated commodity prices, even if the Canadian economy were to be tepid.”
- Select versus broad-based multiple expansion. “We believe that low- and medium-priced stocks can still benefit from a P/E multiple expansion as either headwinds to growth and earnings recede or earnings growth picks up,” he says. Some companies he owns with medium-to-low P/E ratios are Stantec, SNC-Lavalin, CGI Group, and OpenText Corp.
The impact of interest rates
Interest rate increases could impact Chapman’s bullish outlook for Canada. But, “to end this bull market, we believe it will take much higher long rates and/or a more expensive stock market to end the bull market in non-resource stocks,” he says.
“As interest rates rise, reflecting an improving U.S. economy, earnings growth will drive stocks higher—until interest rates rise to a level that either crimps valuations, or the yield [curve] inverts, signaling a recession to come,” he adds.
But this won’t happen this year, he predicts. “Long rates impact valuation outlooks, while short rates impact earnings outlooks. We’re positive for 2017,” says Chapman. “We don’t think we’re close to the point where higher interest rates will choke off the bull market.”
There are headwinds he’s watching. First, says Chapman, “We’re concerned about what President Donald Trump might do on the trade front, and that’s still a risk. We’re particularly concerned about the notion of a border adjustment tax, or BAT, which effectively [would] have the role of taxing imports by 20% and crediting exports by 20% for income tax deductibility.”
It’s unclear whether the BAT will be implemented. While Trump’s administration unveiled its tax plan on April 26, the one-page plan included little detail. As The Washington Post reports, what has been released so far has resulted in “a lobbying dogpile,” with industry groups rushing to defend tax breaks and others pushing to “simplify” the tax code. Politico.com reports the tax plan has resulted in “the next great tax-reform fight in Washington.”
Further, Trump is now struggling with the controversy over James Comey, the ousted FBI chief, and allegations the president asked the agency to halt an investigation.
Outside of North America, Chapman says it’s still possible for an anti-EU party to be elected in one of the 2017 European elections, though this is less of a concern. “As we’ve seen in the Dutch election and the French election, this has not been the case, so this risk is greatly diminishing. In any event, we believe the U.S. and Asia could grow without Europe as it has been doing for a great number of years.”
Plus, he’s constructive on oil and gold, which is why “the resource part of [Canada’s] market can also participate in our positive outlook.”