Two sectors drive over 55% of the S&P/TSX Composite index; Financials & Energy. Will they move the index higher or lower in 2016? MaryAnn looks at the Bull & Bear case for the TSX with Anita Bruinsma, Equity Analyst, TD Asset Management.
Will they move the index higher or lower in 2016?
Today we look at the bull and bear case for the TSX and let you make up your mind.
Anita Bruinsma, Equity Analyst, TD Asset Management, will give us her top three points for the bulls, and then the bears.
Here we go.
Number one is oil and energy stocks should rise.
Well, as you know, MaryAnn, oil is a very important factor in determining how Canadian equities perform.
The energy stocks make up about 18% of the index and the oil price has impacts on other sectors as well.
So the bulls would argue that the oil price is set to rise this year.
So why would this happen?
It's mainly about a slow-down in supply growth.
So let's start with the U.S. This was the world's largest oil producer last year.
So, drilling activity in the U.S. in the past 18 months or so has come off really dramatically and so it could happen in 2016 that we finally see the production also come down.
And then we look at Saudi Arabia, which is the second largest producer of oil globally.
Now, Saudi Arabia is running fiscal deficits at these low oil prices.
So at some point they might say, "Okay, we're going to curb production and let the oil price rise a little bit." And then, lastly, if you look kind of generally among oil companies, the debt levels are high and a lot of them are starting to face this financial distress, so at some point some of that production has to come off as well.
So if we get that better supply-demand balance this year, the oil price could go up.
And number two is banks are undervalued.
So banks also make up a significant part of the index.
In fact, almost a quarter of the TSX, so obviously, a very important driver.
So last year bank stocks fell by about 9%.
The valuations are running well below the long-term average.
And in fact, the short interest in the Canadian banks is at all-time highs.
So, really, investors, I think, are most concerned about credit losses.
So this is the inability for consumers and companies to pay their loans, mortgages, etc.
But if we look at consumer debt, the key driver to a consumer being able to pay their loan is the unemployment rate.
You know, if you don't have a job, you don't pay your loan.
So we hear a lot about job losses in the oil patch in Alberta, but the reality is 75% of Canada's jobs are in Ontario, Quebec and BC, and the outlook for those provinces are actually pretty good.
Then we look at interest rates.
So I think everyone can agree that interest rates aren't going much higher this year in Canada.
So if they stay low, this is going to be good for low mortgage rates and overall for consumer affordability.
And then, lastly, when we look at the direct loan exposure that banks have to oil and gas companies, that exposure is actually really quite low.
So, if we see over the next couple of quarters that the credit trends in the banks aren't deteriorating that much, sentiment could improve on the banks and the stocks could go up.
And number three is investor sentiment should improve.
We don't have time to talk about the other 45% of the market in detail but let's talk generally.
So sentiment on Canada has been very, very poor.
But there is the chance that after these, you know, several years of underperformance relative to the U.S. that we could see a shift in sentiment.
This would happen if the oil price went up.
Obviously that would be very good for the economy and for sentiment, but I think there are also supportive factors for the economy that could shine through.
For example, you know, the Bank of Canada still has some monetary policy tools that it can use, the Liberal Government is talking about infrastructure spending and tax cuts, which could boost GDP, and of course, the low Canadian dollar helps our competitive position, so we could see exports go up.
So I think once some of these factors come shining through, we could see a turn in sentiment on Canadian equities.
So number one, oil could remain low.
The bears would argue that the oil price could stay at or near these levels for the entire year.
There are a couple of risk factors to the oil price.
The first is the demand side.
So demand growth could be challenged.
We do--we are in a very low-growth world in terms of global GDP and there's concern in particular that growth could slow--demand growth could slow out of China.
Then we look at the supply side.
So I talked about how Saudi Arabia is running these deficits, but they can actually sustain these deficits for quite a while.
So there's the chance that they just kind of keep feeling this pain, keep producing and keep the oil price low to drive others out of the market.
And then, in the U.S., as I mentioned, we've seen significant decline in drilling activity, but the production levels last year stayed remarkably strong.
So the risk is that this continues into 2016 where we don't see that fall-off in production as quickly as we need to see it.
So if we get that supply- demand imbalance again this year, the oil price could well stay where it is.
And number two is bank headwinds could weigh.
The bears will pull--will point to several headwinds for Canadian bank earnings this year.
The first is interest rates.
So low interest rates are not good for bank earnings, and so if the Bank of Canada cuts rates again, this will once again compress the interest margin that the banks earn and be negative for earnings.
And then the second is loan growth.
So loan growth has been a significant contributor to bank earnings over the past several years.
Consumers have loved the low interest rate environment, taken on a lot of debt, but now their debt levels are really high so it feels like there's not a lot of room for them to add, and so earnings growth won't get that tailwind.
And then, lastly, it's that credit issue, the loans issue we talked about earlier.
The bears will say that the loan losses are going to rise significantly because consumers are stressed with high debt levels, because the unemployment rate could rise, and so if we see this happening, the bears argue that despite cheap valuations on the banks, those valuations aren't likely to rise any time soon.
And number three is sentiment does not improve.
The bears point to several headwinds that the Canadian economy faces this year.
So obviously, if the oil price stays low, there is--you know, there's no extra boost to economic growth and people aren't going to feel particularly good about Canada.
The other concern that people have is our housing market.
So the housing market has really contributed to GDP growth over the last several years and it feels like maybe now we're sort of at the end of that cycle.
So the economy won't get the same tailwind that it has.
So the bears will argue that there's really no reason for investors to get more optimistic on Canada in 2016.
So what's your opinion?
Well, we feel there are a lot of supporting factors for Canadian equities in 2016, but we do have to temper that in the context of the slow economic growth globally that we're seeing, and particularly slow economic growth in Canada.
But we do think Canadian equities can produce at least modest returns.
And what's most interesting is that there are a lot of high-quality stocks that have come back quite a bit and present good entry opportunities for the longer term investors for longer term returns.
We also do expect the markets could be quite volatile and this could present even more interesting buying opportunities in 2016.
Thank you very much, Anita.
So there you have it.
The bulls and bears case for the top two sectors of the TSX.
Here with Anita Bruinsma of TD Asset Management.
I'm MaryAnn Devenney.
Thanks for watching.