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2010: Recovery year
Thu, Dec 24 2009, 11:15 GMT
Investors have taken heart from signs of economic recovery and corporate earnings growth. The 50%-plus equity rebound that began in March has yet to abate. Can this rally chug right along into 2010?
After the worst plunge in decades, U.S. profits are about to rebound on the wings of economic recovery. We are pleased to see that Q3 national-accounts profits were up 11.3% from the previous quarter. And profit growth is essential to employment growth.
For the North American stock indexes, the analyst consensus sees 2010 earnings growth of 25.4% in the U.S. and 26.5% in Canada. It should be kept in mind that rebounds of 25%-plus are not unheard of in post-recession periods.
Abundant liquidity still awaits deployment in securities of higher risk and higher return. Assets in money market funds are now 31% of all mutual fund assets, higher than the historical average of 29%. In 2009, individual investors preferred fixed income instruments to get back in the game – the risk-averse went for bonds even as rates fell to decade lows. But how long will investors stay with ultra-low yields before they regain appetite for the risk and yield of assets such as stocks?
We expect a total return of zero from the DEX Canadian bond universe next year. At this point, our preference goes to corporate and provincial over federal bonds. We reiterate our recommendation to underweight fixed income assets and overweight equities.
Last month we introduced stock index targets for year end 2010. Given today’s low fixed-income yields, we would be comfortable with an expansion of P/Es to 16 in the year following the recession bottom. On the basis of our 2010 earnings expectation of 80 for the S&P 500, we reiterate our 12-month target of 1280 for the U.S. index – an advance of 15% from the current level. For the Canadian benchmark, our earnings expectation of 800 takes us to a 12-month S&P/TSX target of 12,700, 10% above the current level.
Our current sector rotation is positioned for above-trend global GDP growth. At the end of a recession / beginning of a new expansion, investors typically shun value stocks and look for growth. Cyclical sectors usually thrive in these periods of recovery. The analyst consensus expects next year’s strongest earnings improvements to be posted by the Energy, Materials, Consumer Discretionary and IT sectors. With the exception of the gold mining industry (71% of Materials in Canada), these are also our preferred sectors.
The equity rally that began in March has yet to abate.
Stocks always rally strongly toward the end of a recession, and this cycle has been no different. At this writing the S&P 500 index is up more than 60% and the S&P/TSX more than 50% from their March 9 lows.
The story has been similar in the rest of the globe. The major stock indexes have rallied strongly. Leading them all are the BRIC countries (Brazil, Russia, India, China), whose benchmark indexes have doubled from their March lows.
Investors have taken heart from signs of economic recovery and corporate earnings growth. Can this rally chug right along into 2010?