February 2015
Highlights

Though whipsawed for much of January, global equity markets have been resilient. We note that emerging markets
are leading the pack, which is unusual in a time of USD appreciation. Globally, we note that Brent oil is diving while
leading indicators are trending up, a development likely to benefit most households.

With expansion now in full swing, the U.S. earnings outlook remains favourable. A quarter of the way into the Q4
earnings season, outcomes are running above expectations. Though some sectors of the S&P 500 are beginning to
feel drag from the strong U.S. dollar, we doubt this will have much effect on the economy as a whole. True, about
40% of S&P 500 profits are earned overseas. But for national-accounts profits the share falls to 20% .

At this juncture, we remain comfortable with our recommendation to overweight equities relative to our benchmark
while maintaining a slight underweighting in fixed income products. We are staying with an overweight
recommendation for the S&P/TSX early in 2015. This call hinges on our assumption of lower oil production and a
delay in U.S. rate hikes (in order to limit USD strength). Our year-end targets are 16,200 for the S&P/TSX and 2,220
for the S&P 500.
Stéfane Marion
[email protected]
Matthieu Arseneau
[email protected]
MONTHLY EQUITY MONITOR
A volatile start to 2015
World: A highly unusual dynamic
OECD leading economic indicators and Brent oil price
Though whipsawed for much of January, global equity
markets have been resilient. At this writing the MSCI
AC World index is up 0.8% year to date with most
regions positive. We note that emerging markets are
leading the pack, which is unusual in a time of USD
appreciation.
Global equity market performance (Year-to-date)
MSCI AC World
0.8
MSCI World
0.6
MSCI USA
1.3
4.2
MSCI Pacific ex Jp
2.9
1.4
MSCI EM
3.1
MSCI EM EMEA
5.2
MSCI EM Latin America
-1.9
MSCI EM Asia
%
3.8
-3
-1
1
3
5
NBF Economics and Strategy (data via Datastream)
P/Es since 1988: MSCI World and MSCI Emerging Market
Price to 12-month forward earnings
(left)
130
World
120
(left)
110
100
98.5
98.0
97.5
97.0
90
80
70
60
96.5
96.0
95.5
Brent oil
40
(right)
50
30
2007
2008
2009
2010
2011
2012
2013
2014
20
2015
But there’s more. The price of food has also been
falling (second chart below) and so have interest
rates. That makes three sources of relief for the
disposable income of global consumers. The lift they
bring will be felt most in urban areas of emerging
economies, where food and energy generally account
for two-thirds of the CPI basket. Thus it is hardly
surprising that the consensus expects double-digit
earnings growth for the MSCI EM index (10.1%, table).
World: Food prices since 2007
CRB Foodstuffs (in USD)
28 Ratio
520 Index
26
500
480
24
460
22
440
20
420
−20%
400
World
18
380
16
360
14
340
12
320
300
10
280
8
6
160
150
OECD 140
NBF Economics and Strategy (data via OECD)
MSCI Europe
MSCI Japan
US$ / barrel 170
100.5
100.0
99.5
99.0
95.0
2006
-1.2
MSCI Canada
102.5 Index
102.0
101.5
101.0
Emerging
1990
1995
2000
2005
2010
2015
NBF Economics and Strategy (data via Datastream)
260
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4
2007
2008
2009
2010
2011
2012
2013
2014
NBF Economics and Strategy (CRB data via Datastream)
So why are emerging markets outperforming? To
answer this question we need perspective on the
impact of a supply-induced oil-price collapse. Globally,
we note that Brent oil is diving while leading indicators
are trending up, a development likely to benefit most
households.
2
MONTHLY EQUITY MONITOR
MSCI indexes: % EPS growth, y/y and 12-month-forward
MSCI AC World
MSCI World
MSCI USA
MSCI Canada
MSCI Europe
MSCI Pacific ex Jp
MSCI Japan
MSCI EM
MSCI EM EMEA
MSCI EM Latin America
MSCI EM Asia
1/27/2015
2013
8.1
6.4
8.4
-6.2
-5.4
0.0
NA
19.7
87.0
5.4
8.3
2014
4.4
5.1
5.0
12.6
2.1
8.1
74.8
0.0
-13.1
-8.9
7.1
2015
6.2
5.6
5.2
-2.6
6.8
0.7
11.1
9.7
2.6
13.4
11.1
2016
12.2
12.2
13.0
14.8
12.2
8.3
11.0
11.9
12.6
17.3
10.5
12 forward
growth
7.0
6.6
6.3
-0.6
7.3
3.6
11.0
10.1
4.5
13.7
11.0
NBF Economics and Strategy (data via Datastream)
U.S. earnings trending up
This low interest rate environment has significant
ramifications on relative valuations of financial
assets. We note that the current gap between the
U.S. earnings yield and long-term interest rates is
unusually large for a U.S. expansion (the current one
began officially in September 2013). Based on this
perspective, equities do not look particularly
expensive.
U.S.: Valuations since 1960
Though the outlook for global growth is generally
promising, industrial production will grow more slowly
than in the past decade. The most recent data, for
November, show volume industrial production in
emerging Asia up 4.2% from a year earlier, the slowest
pace since the 2008-09 recession (chart). This
deceleration is consistent with China’s decision to
emphasize the development of its service economy
over the addition of industrial capacity. The end result
is that the trend growth of global IP is probably closer
to 2% than to 3%-4% (chart).
S&P 500 earnings yield, Moody’s Baa corporate yield, 30-year government bond
(constant maturity)
18 %
17
16
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1960
S&P 500: 6.2%
Baa: 4.5%
30-years: 2.5%
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
NBF Economics and Strategy (data via Datastream)
Global industrial production since 1995
24 % y/y
20
16
12
Emerging
Asia
8
4
World
OECD
0
Asian
Crisis
-4
-8
-12
-16
-20
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
NBF Economics and Strategy (data via CPB)
That doesn’t mean global GDP and earnings cannot
grow faster than industrial production in 2015. In fact,
all eyes should be riveted on services this year: this
is the part of the economy most likely to benefit from
higher consumer spending as energy and food prices
decline and highly stimulative monetary policy in
most regions of the world keeps interest rates low all
along the yield curve (and negative in some countries).
Moreover, with expansion now in full swing, the U.S.
earnings outlook remains favourable. A quarter of the
way into the Q4 earnings season, outcomes are
running above expectations. Of the 128 companies
reporting at this writing, 97 have surprised on the
upside. The overall “beat factor” is an impressive
4.6%. Though some sectors of the S&P 500 are
beginning to feel drag from the strong U.S. dollar, we
doubt this will have much effect on the economy as a
whole. True, about 40% of S&P 500 profits are
earned overseas. But for national-accounts profits the
share falls to 20% .
3
MONTHLY EQUITY MONITOR
U.S.: Profits remain firm
Before-tax profits (with IVA and CCA), national-accounts basis
Total
2,200 $ billion
2,000
Domestic
1,800
1,600
1,400
1,200
The domestic
economy
accounts for
80% of all
U.S. profits
1,000
800
600
400
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
NBF Economics and Strategy (data via Datastream)
The story for 2015 is quite different from that of the
early days of recovery from the last recession, when
the U.S. needed exports for an unusual portion of its
growth. This time around, we think the focus must be
on domestic indicators – consumption, construction,
the labour market. Particularly encouraging is the
January surge of consumer confidence coupled with
the large rise in the share of survey respondents
expecting their incomes to increase in the next six
months (chart).
increases both downside risks to the inflation profile
and financial stability risks.” Consequently the central
bank lowered its inflation forecasts, projecting that
neither core nor headline inflation would return to 2%
before late 2016.
The BoC move sank the Canadian dollar to a new
multi-year low of 80 cents US. Many investors want it
lower still. While a small depreciation might still be
possible – we see the Bank cutting its overnight rate
another 25 basis points – we think the CAD is near its
bottom. After all, it has depreciated more than 20%
over the last 24 months. As the next chart illustrates,
a move of that magnitude is unprecedented. If oil
prices stabilize and/or if the Federal Reserve delays
the launch of its tightening (it wouldn’t be the first time
this year that a central bank has surprised markets),
there is scope for some firming of the Canadian dollar.
Meanwhile, we note that the depreciation of the CAD
over the last two years is beginning to catch the
attention of equity analysts. Profit expectations for the
S&P/TSX have become much less downbeat: the onemonth change in 12-month forward earnings shows
signs of stabilizing for the first time since last summer
(chart).
Canada: Record CAD depreciation offers hope for earnings
U.S.: Consumers very optimistic on future income
Canadian dollar: % 24-month change
% of consumers surveyed who expect to have higher incomes in 6 months
23 %
22
21
20
19
18
17
16
15
14
13
12
11
10
9
8
7
2005
S&P/TSX: change in 12-month forward earnings
32 %
28
Jan. 2015
24
16 %
12
Record CAD depreciation …
8
20
0
12
-4
8
4
-8
0
-12
-4
3-month change
-16
-8
-20
-12
… offers hope
for earnings
-24
-16
-28
-20
-24
1-month change
4
16
1975
1980
1985
1990
1995
2000
2005
2010
2015
-32
2007
2008
2009
2010
2011
2012
2013
2014
NBF Economics and Strategy (data via Datastream and Federal Reserve Bank of St. Louis)
2006
2007
2008
2009
2010
2011
2012
2013
2014
NBF Economics and Strategy (data via Datastream)
Canada: What to think?
The Bank of Canada began the year with a bang,
moving its policy rate for the first time in four years.
Unexpectedly, the move was a cut – 25 basis points,
to 0.75%. The BoC’s argument was the risk to growth
posed by slumping oil prices: “The oil price shock
It will be interesting to see how the Q4 announcement
season unfolds. As of January 23, the consensus sees
earnings growth of 5.2% from a year earlier with gains
in seven of the 10 TSX sectors, led by IT (+362.5%)
and Consumer Staples (+46.8%). Materials (−21.5%)
and Utilities (−21.0%) are expected to be the
laggards.
4
MONTHLY EQUITY MONITOR
Asset allocation
At this juncture, we remain comfortable with our
recommendation to overweight equities relative to our
benchmark while maintaining a slight underweighting
in fixed income products. Our year-end targets are
16,200 for the S&P/TSX and 2,220 for the S&P 500.
We are staying with an overweight recommendation
for the S&P/TSX early in 2015. This call hinges on our
assumption of lower oil production and a delay in U.S.
rate hikes (in order to limit USD strength). Though the
timing of a supply response to sharply declining crude
prices is uncertain, we think U.S. oil output could
decline as soon this year. The most recent report from
Baker Hughes shows a sharp contraction of the U.S.
rig count in January. As the next chart shows, the
decline in the number of horizontal rigs (used for
shale-oil production) is the largest since the recession
of 2008-09. We also note that U.S. output dipped at
that time and then was stable for two years.
Change in number of horizontal rigs vs. U.S. weekly output
Thousands of barrels per day* 9,200
U.S. field
output
(right)
120
80
40
8,800
8,400
8,000
7,600
7,200
6,800
6,400
6,000
5,600
5,200
4,800
4,400
0
3-month change in 12-month forward earnings growth
50 %
40
30
20
10
0
-10
-20
-30
-40
-50
2002
2004
2006
2008
2010
2012
2014
Sector rotation
Our sector rotation is unchanged this month.
NBF Asset Allocation
Benchmark
NBF
Change (pp)
(%)
Recommendation (%)
Equities
-40
Canadian Equities
-80
Rig count
(left)
-120
-160
Canada: Energy sector pummelled
NBF Economics and Strategy (data via Datastream)
U.S.: Will the drop in rig count affect production?
8-week change
wake of a full-fledged global credit crisis. There is
much bad news already priced into Canadian energy
stocks and we certainly do not think 2015 will be as
bad as 2008-09 for the global economy. If supply
stabilizes and demand accelerates with world GDP,
we would expect oil prices to be about $10 a barrel
higher by year end.
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
* 13-week moving average
NBF Economics and Strategy (data via Baker Hughes)
If this sequence is repeated, the door will be open for
an energy-driven rebound of the S&P/TSX. In the last
few weeks, as the next chart shows, equity analysts
have slashed earnings expectations to the same
extent as in the 2008-09 recession, when the fall of
oil prices reflected concerns over demand in the
30
33
U.S. Equities
10
12
Foreign Equities (EAFE)
10
7
5
8
30
30
Emerging markets
Fixed Income
Canadian Bonds
Foreign Pay Bonds
0
0
Real Return Bonds
10
5
Cash
5
100
Total
NBF Economics and Strategy
5
100
5
MONTHLY EQUITY MONITOR
NBF Market Forecast
NBF Market Forecast
Canada
United States
Index Level
S&P/TSX
Actual
Q4 2015 (Est.)
Jan-27-15
Target
Index Level
14,834
16,200
S&P 500
Q4 2015 (Est.)
935
446
17.3
Q4 2015 (Est.)
0.46
1.84
Assumptions
Assumptions
Level:
Earnings *
Dividend
PE Trailing (implied)
Treasury Bills (91 days)
10-year Bond Yield
910
435
16.3
0.62
1.43
* Before extraordinary items, source Thomson
Level:
Earnings *
Dividend
PE Trailing (implied)
Treasury Bills (91 days)
10-year Bond Yield
Actual
Q4 2015 (Est.)
Jan-27-15
Target
2,030
2,220
116
40
17.4
0.02
1.83
Q4 2015 (Est.)
126
44
17.6
Q4 2015 (Est.)
0.69
2.28
* S&P operating earnings, bottom up.
NBF Economics and Strategy
6
MONTHLY EQUITY MONITOR
NBF Fundamental Sector Rotation - February 2015
Name (Sector/Industry)
Recommendation S&P/TSX weight
Energy
Energy Equipment & Services
Oil, Gas & Consumable Fuels
Overweight
Overweight
Overweight
21.5%
0.8%
20.7%
Materials
Chemicals
Containers & Packaging
Metals & Mining *
Gold
Paper & Forest Products
Market Weight
Underweight
Market Weight
Market Weight
Market Weight
Overweight
12.1%
3.5%
0.2%
2.5%
5.4%
0.5%
Industrials
Capital Goods
Commercial & Professional Services
Transportation
Market Weight
Overweight
Underweight
Market Weight
8.6%
1.7%
0.7%
6.3%
Consumer Discretionary
Automobiles & Components
Consumer Durables & Apparel
Consumer Services
Media
Retailing
Underweight
Underweight
Overweight
Underweight
Market Weight
Underweight
6.3%
1.6%
0.6%
0.9%
2.2%
1.2%
Consumer Staples
Food & Staples Retailing
Food, Beverage & Tobacco
Underweight
Underweight
Underweight
3.7%
3.0%
0.7%
Health Care
Market Weight
Health Care Equipment & Services
Market Weight
Pharmaceuticals, Biotechnology & Life Sciences
Market Weight
4.1%
0.8%
3.3%
Financials
Banks
Diversified Financials
Insurance
Real Estate
Market Weight
Market Weight
Market Weight
Overweight
Market Weight
34.1%
21.2%
1.4%
6.5%
5.1%
Information Technology
Software & Services
Technology Hardware & Equipment
Overweight
Overweight
Market Weight
2.4%
1.8%
0.6%
Telecommunication Services
Underweight
5.0%
Utilities
Underweight
2.3%
* Metals & Mining excluding the Gold Sub-Industry.
7
MONTHLY EQUITY MONITOR
ECONOMICS AND STRATEGY GROUP
514-879-2529
Stéfane Marion
Chief Economist & Strategist
[email protected]
Paul-André Pinsonnault
Senior Fixed Income Economist
[email protected]
Krishen Rangasamy
Senior Economist
[email protected]
Marc Pinsonneault
Senior Economist
[email protected]
Matthieu Arseneau
Senior Economist
[email protected]
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