Where to invest in the back half of 2017

It’s been a tough few months for investors in the Canadian markets. Although the domestic economy is performing relatively well, the stock market has struggled to repeat last year’s impressive returns. But, could the Canadian market be about to turn things around and what’s caused the past few months’ woes?

Kurt Reiman, BlackRock's Chief Investment Strategist for Canada, believes three key issues have prevented the Canadian market from pushing ahead this year. The first is related to where the Canadian market started out the year from a valuations perspective – the market was trading at a level that meant future returns could only be limited.

The volatility in oil prices has also hit the Canadian market. At the beginning of the year, many analysts were forecasting oil prices to rise into the high 50s over the course of the next year, which now looks far from becoming a reality.

“The third issue is primarily to do with sector composition and is also linked to oil prices,” Reiman says. “Canada’s outsized exposure to energy has been a real drag relative to global markets, as has its substantial underweight to secular growth sectors, like tech and healthcare, which have led the market higher this year. Those sectors are under-represented in the TSX.”

Reiman is more positive about Canada’s market in the second half of the year and believes one of the issues that dragged it down initially – valuations – could play an important role in its recovery. Because of the sustained underperformance compared with the U.S., the Canadian market is now trading at a relative valuation to the U.S. that, going back to 1987, has only been seen 25% of the time, Reiman explains.

“Rarely is the Canadian market this cheap and usually when it is, it doesn’t imply sustained underperformance - it rather implies an ability to stage something of a comeback,” Reiman says. “I also think oil prices will stabilize in the new lower range for the back half of this year. Where Canada may have been penalized for having too little exposure to things like bond proxies and secular growth, the Canadian market will be rewarded for its over exposure to a style that will outperform, which is value.”

Despite stretched valuations, Reiman believes the U.S. market is well-positioned to move higher in the second half of the year. However, for Canadian investors with a lot of their international exposure tied up in the U.S., Reiman suggests looking at other international markets with good earnings growth but where monetary policy is still accommodative and is not being reversed quite as rapidly.

In particular, Reiman remains positive on Europe and Japan. In Europe, concerns around populism and the breakup of the EU have lessened significantly. The economic recovery shows all the signs of being robust and sustainable and is growing at a pace that is above potential, despite the region’s demographic concerns.

“The same is true for Japan,” says Reiman. “Demographic headwinds are there but, despite the aging effect, the domestic consumer seems to be in really good shape. Unemployment rates are historically low and that economic growth is translating into better earnings. From our standpoint, there is still room to run because valuations don’t yet reflect this more positive environment.”


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