Global equity markets have been under pressure in recent weeks

Highlights

• Global equity markets have been under pressure in recent weeks, with most of the major regional indexes in decline. The price of oil – WTI still below US$60 a barrel – is the main excuse for the selloff. Though most equity indexes (including the S&P/TSX) are still up in 2014 to date, financial markets continue to ponder the significance of the oil price slide. For some, it is a clear symptom of a weakening global economy, as is the drop in Treasury yields. For others, it is rooted in an OPEC supply-shock experiment aimed at recapturing lost market share. We side with the optimists.
  

• Since the oil price slide exacerbates the decline of market interest rates by softening inflation, consumers worldwide are enjoying a potent spending stimulus that will benefit growth. On the other hand, the economies of OPEC members and Russia, with large oil net exports are being pummelled. Angola, Venezuela, Algeria, Iran, Iraq, Nigeria and Russia could be in for outright contractions due to a deterioration of their terms of trade ranging from 5% to 25% of GDP.

• Investment incentives in the U.S. energy sector have fallen to a 40-year low. With the U.S. Department of Energy now forecasting that shale oil production will flatten in 2015, capital spending could fall $30 billion next year. Thus the supply of oil could stabilize. Meanwhile, the International Energy Agency (IEA) sees demand rising 1.1% in 2015, up from 0.7% this year. Our current call is continued expansion of the global economy in 2015 with oil averaging US$70 a barrel. For 2016 we assume $80 a barrel.

• Going into 2015, we remain comfortable with our recommendation to overweight equities relative to our benchmark while maintaining a slight underweighting of fixed income products. Our year-end targets for 2015 remain at 16,200 for the S&P/TSX and 2,220 for the S&P 500. We are modifying our global equity allocation this month. We are increasing our S&P/TSX exposure to overweight for the first time since last summer and reducing our overweight stance on the S&P 500. We are also making changes to our sector allocation. We are upgrading the energy sector from market weight to overweight. To accommodate this change, we are reducing financials to market weight.