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August 2016 – Markets at Record Highs, More to go in Spite of the U.S. Election
With the S&P 500 and S&P/TSX Composite at record highs, the key question is where to go from here? In our opinion, the path of least resistance is likely higher from now until the end of the year since: (1) bullish sentiment remains very subdued (a good contrary indicator) (2) economic momentum is improving in North America (3) very easy monetary policy and low interest rates globally.
Clearly, markets do not go straight up. Our team believes that any weakness in stocks from here should be used as a buying opportunity for high quality U.S. and Canadian stocks, particularly in the cheaper and more economically levered financial, industrial, technology, consumer discretionary, energy and basic materials sectors.
Given the year to date recovery in oil and other commodity prices and the general improvement in economic leading indicators, we tweaked our fair value estimates upward for the S&P 500 to 2,350 – 2,400 (from our long standing 2,300 fair value estimate) and 15,500 – 16,000 for the S&P/TSX (from 15,000). We believe our earnings growth and discount rate assumptions are sufficiently conservative, especially given the very low interest rate environment which should be with us for an extended period of time.
Despite markets making several successive historical highs, the percentage of investors describing themselves as "bullish" remains remarkably low at 37%, implying that that sentiment has plenty of room to improve in the back half of the year.
Looking at the macro environment, as BMO Chief Economist Doug Porter recently wrote: "…there have been a number of supportive developments... First, both the U.S. and Chinese economy have posted generally upbeat results in recent weeks. Stateside, the strong rebound in June jobs was followed by solid retail sales and industrial production growth in the same month… At the same time, China Gross Domestic Product (GDP) slightly topped expectations with a 6.7% year over year (y/y) advance in Q2, triggering a rare upward revision for a major economy. Meantime, Japan looks headed for more aggressive stimulus, with Prime Minister Abe’s hand strengthened by his party’s win in the Upper House elections. Even the U.K. political backdrop calmed, with a new prime minister in place two months ahead of plan, while the Bank of England has all-but-promised to deliver stimulus at their next meeting in early August—and this time they really, really mean it.
In other words, a combination of better-than-expected economic news on the ground in many major economies as well as the prospect of some new stimulus measures in some other key economies have soothed markets. There is likely also the dawning realization that Brexit’s bark may be much worse than its bite for most of the rest of the world, a point we tried to make in the immediate wake of the vote. No doubt, it is an unwelcome new source of uncertainty. But, unless it ultimately leads to a break-up of the Eurozone itself, Brexit is unlikely to do much serious damage to the broader global economy."