- Year-end target for S&P/TSX Composite updated to
15,300 – a reflection of improved profit margin
potential
- Fair-value range for the CAD/USD exchange rate tightened to
0.89-0.94 USD per CAD
- Russell global investment strategist team cautions there
could be market shocks given investor complacency, unsustainably
low volatility and stretched equity market valuations
TORONTO, July 23, 2014 /CNW/ - Improving profit margins
and firm commodity prices have led to an increase Russell
Investments' year-end target for the S&P/TSX Composite Index
from 13,800 to 15,300 according to the firm's Q3 2014 Strategists'
2014 Global Outlook Update, which reflects the most recent guidance
for the firm's multi-asset portfolios and services from Russell's
global team of investment strategists, including commentary
specific to the Canadian equity market.
"Our upgrade is not necessarily a reflection of being more or
less bullish; rather, it's a reflection of improving profit
margins," said Shailesh Kshatriya, associate director, client
investment strategies at Russell Investments Canada, who authored
the Canada Market Perspective section of the global report. "While
this shift occurred sooner than we anticipated, we believe the
improving outlook is being supported by several notable trends,
including: rising oil prices, continued strong results from the
banks, and market multiples - which have been aided by the strength
in the energy and financial sectors."
In addition, Kshatriya believes increased economic activity as
the U.S. rebounds over the course of the year should also reinforce
domestic trends. "As such, we no longer expect multiples to
contract for the balance of the year, but remain stable. And
pertaining to economic growth, we expect it rebounds from weak Q1
levels, finishing the year between 2-2.3%." At the same time,
Kshatriya believes the market is susceptible to a mild correction
before it moves forward, and remains cautious in the interim.
In terms of the direction of the loonie, Kshatriya believes the
Canadian dollar is in a losing battle and has tightened the
fair-value range for the CAD/USD exchange rate to 0.89-0.94 USD per CAD, versus the prior range of
0.90-0.98. According to Kshatriya, the days of the Canadian dollar
trading near parity to the U.S. dollar are over, and the loonie
most likely needs to be lower for longer in order to improve
competitiveness and add some life to the fading manufacturing
sector.
For the global equity markets overall, Russell's global team of
investment strategists maintain their point of view stated in the
2014 Annual Global Outlook - a modest preference for
equities over fixed income globally - though with a slightly
diminished spread for the U.S. market. However, the combination of
volatility near all-time lows (as measured by the VIX Index),
investor complacency and stretched equity market valuations, is
leading them to caution that the markets are especially vulnerable
to shocks.
"We're calling current market conditions the 'great
re-moderation' as they appear similar to the low-volatility,
high-return markets we saw prior to the 2008 global financial
crisis," said Russell's Global Head of Investment Strategy,
Andrew Pease. "This time though, we
think recession risks are low and a major market reversal seems
unlikely. However, volatility could easily spike, creating a
temporary shake-out, which we'd see as a 'buy-the dips'
opportunity."
In the report, the team highlights the impact on their outlook
of three surprises that were seen in the first half of 2014: the
-2.9% contraction in first-quarter U.S. Gross Domestic Product
(GDP), the large rise in U.S. core inflation, and the decline in
volatility across all asset classes to levels believed to be
unsustainable in the long run. In addition, they cite a list of
geopolitical risks, such as the events escalating in Iraq, the ongoing China-Japan
dispute in the East China Sea as well as the Urkaine-Russian
conflict. Finally, the strategists highlight the possibility of an
inflation scare, beyond the rise of the core U.S. Consumer Price
Index (CPI) from 1.6% in January 2014
to 2.0% in May and the Personal Consumption Expenditure (PCE)
deflator from 1.1% to 1.5% in the same time period.
Despite these changing considerations, the team's investment
strategy views remain largely unchanged, in part due to strong
economic growth in the first half of 2014 and positive economic
forecasts going forward. The team predicts monthly gains in U.S.
non-farm jobs to average 230,000 over the next 12 months and the
U.S. Federal Reserve's (the Fed) interest-rate hikes to be held off
until mid-2015.
"Mid-year data points support our outlook that U.S. 10-year
Treasury yields are likely to rise, default rates will stay low and
support credit spreads, and equities can continue to outperform
fixed income," Pease summarized. "The CPI rise appears to be more
noise than signal. Our models suggest core inflation will stay
close to 2% through 2015."
Russell's strategists continuously update their market forecasts
amid a changing market environment by implementing a three-pronged
"value, cycle, sentiment" investment strategy process, which
combines qualitative views and quantitative inputs. Based on this
process, Russell's current global market perspectives are as
follows:
- Value: U.S. appears more expensive, Europe less so and Japan's valuation shifts into neutral
Russell's strategists agree that little has changed on
market valuations in the past three quarters. They believe the U.S.
has become marginally more expensive as the market reaches record
highs, with the cyclically adjusted price/earnings ratio for the
U.S. large-cap Russell 1000® Index at more than 20
times, and the price-to-book value is around 2.8 times.
They also see European equities as modestly expensive and score
Japan's valuation as neutral.
Emerging markets (EM) remain undervalued by 30% to 40% relative to
developed markets equities.
- Cycle: Eurozone growth expectations improving, U.S. regains
its footing
The team of strategists sees business cycle indicators as positive
for the developed economies, and they believe growth should
strengthen across the United
States and Europe over the
remainder of the year, but feel that uncertainty remains in other
markets.
Supporting this view is the fact that Institutional Broker Estimate
Service (IBES) consensus earnings-per-share growth forecasts for
the Russell 1000 companies have stabilized near 8% as of early
July 2014. For the U.S. specifically,
the strategists are not placing much weight on the first quarter
2014 GDP growth figure, and believe the indicator should track
between 2.5% to 3.0% for the next few quarters.
- Sentiment: Positive momentum continues for developed equity
markets
This signal, which reflects price momentum, is based on a
range of indicators on positioning, fund flows, investor
confidence, risk appetite and technicals to judge market sentiment.
The strategists still see momentum as a strong positive driver –
particularly in Europe and the
U.S. – with Europe just ahead of
other regions due to the ECB stimulus package. Overall, the
strategists agree that the low VIX is concerning, but that most of
the other indicators they track are not yet in dangerous
territory.
In summary: "High equity market valuations tell us that the
longer term return outlook is subdued, but for now our value,
cycle, sentiment process and models tell us to favor equities over
fixed income and maintain some credit exposure," Pease said.
For more detailed information, please see the "Strategists' 2014
Global Outlook – Third Quarter Update"
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