Equities to continue the climb higher

Highlights

• Global equities rose to an all-time high in May, with the MSCI AC index brushing off comments from Federal Reserve chair Janet Yellen that stock market valuations may be on the high side if interest rates continue to rise.

• This is not to say that rates will rise much. Jobs gains downshift a bit and wage inflation is still low. At this juncture, we continue to expect the first rate hike in September. All factors considered, we expect a total of no more than 50 basis points of U.S. monetary firming in 2015. The stock market is likely to continue moving up, driven by earnings growth rather than multiple expansion.

• Our recommended asset mix is unchanged this month. We are still overweighting equities relative to our benchmark. Though the prospect of higher interest rates may eventually make equities less attractive, rates are still, in our view, far from levels that would crimp economic growth and profits (say a 10-year Treasury yield above 3%). Our year-end targets are 16,200 for the S&P/TSX and 2,220 for the S&P 500.

• We are modifying our sector rotation this month. We recommend moving Energy from overweight to market weight and raising Financials to overweight from market weight. Though encouraged by the recent rise of oil prices, we are motivated to lower our exposure to Energy by the consideration that it will take a few months to get more clarity on the intentions of the newly elected Alberta government with respect to a potential royalty review and/or carbon tax. Our upgrading of Financials to overweight is motivated by prospects of increased business investment, decent job creation in central Canada and slightly higher market interest rates (driven by U.S. monetary policy), all likely to positive to the banking sector.