Highlights

  • The equity rebound is undiminished. Stock markets always rally strongly toward the end of a recession, and this one is no exception. From the troughs of March 9, the S&P 500 is up 54.4% and the S&P/TSX 48.2%. Globally, equities are up 63.0% from trough. Despite the steepness of the ascent, we think it has not been unreasonable.
  • Last year the IMF published a research paper analysing 113 periods of financial stress in 17 countries over the past 30 years. For closer comparison with the 2008-09 episode, the IMF study focused on six periods of banking-related financial stress leading to economic contractions. In the six episodes surveyed, markets gained an average 48% in the six months following the market trough– a path very similar to that of North American markets this year. In the six episodes studied, the markets rose even further in the second six months after the trough, for an average cumulative rebound of 86%.
  • Of course, the historical models are not very useful if today’s fundamentals are not strong. We think that global economic recovery combined with high margins will buoy earnings in the coming year. The consensus sees 25% earnings growth in 2010, and we agree. Companies have been busy cutting costs over the last two years. As a result, profit margins are the highest since 1970 for the end of a recession. This means that a pickup of the economy will add more to bottom lines than in recent recoveries.
  • The most important market driver in the upcoming profit seasons is likely to be earnings surprises. At this point, what we know is that companies have been more upbeat than usual about their outlooks. Of the S&P 500 companies, 64 have issued negative and 40 have issued positive pre-announcements for Q3. The negative-to-positive ratio of 1.6 is the same as at the equivalent point in Q2, and is below the long-term average of 2.1.
  • The return to job creation that we expect over the next few months will be a major market event. Since investors have not factored in any rate hikes before well into 2010, such a market event might mean a small volatility bump down the road. In the longer term, however, it will confirm the economic expansion. A rate hike would also support the USD by making U.S. interest rates more appealing to foreigners. Resource equities (and particularly gold stocks) could suffer in this scenario because of the strongly negative correlation between commodity prices and the greenback.
  • We are still very comfortable with our overweight stance in equities. Equities usually outperform other assets in the months leading up to and following an economic bottom. Within equities, we continue to overweight U.S. issues and underweight Canadian issues relative to our benchmark. If we are right in our call that the return of job creation will be a major market event, greenback appreciation will add to the return of Canadian investors. Moreover, a stronger greenback would put pressure on resource sectors and especially on gold, a development that would hurt the Canadian market.
  • We continue to favour the higher-growth sectors. Investors have lately been willing to take more risk and go where the earnings growth is. In 2010, the growth vectors will shift to Energy, Materials and Consumer Discretionary stocks.

More expensive but still reasonable

The equity rebound is undiminished. Stock markets always rally strongly toward the end of a recession, and this one is no exception. From the troughs of March 9, the S&P 500 is up 54.4% and the S&P/TSX 48.2%. Globally, equities are up 63.0% from trough.

Despite the steepness of the ascent, we think it has not been unreasonable.