After a brief selloff last week, U.S. equity benchmarks have rebounded to post new record highs. Here in Canada, the TSX has largely been wedged in a sideways trend since the beginning of the year as energy prices struggle and uncertainties about the housing market continue. While U.S. equity valuations appear somewhat extended with the S&P 500 trading at over 18x forward price-earnings, corporate earnings momentum has been strong. As well, the prospects for tax reform and deregulation in the U.S. remain supportive, despite the timing and implementation being less than predictable.
From a global perspective, economic growth and earnings forecasts are trending upward in all major regions for the first time since 2010. In Europe, political risks are ebbing while global reflation and a low Euro currency are helping industrials and multinational exporters. In Asia, financial sector reform and rising account surpluses are encouraging. China’s economic growth and corporate earnings outlook remain solid. With the emerging markets, global reflation and growth in the developed world has been generally supportive.
In Stan Wong Managed Portfolios, we remain constructive on cyclical equities (financials, technology and industrials) while underweight defensive stocks and traditional government bonds. We also generally favour high-quality stocks and expect dividend growers to outperform dividend payers. We still prefer U.S. equities (and the U.S. dollar) over Canadian equities but have allocated some cash to international equities based on attractive relative valuations.
We expect volatility to pick up from its current low as the year progresses — particularly if the political backdrop in Washington deteriorates. We continue to believe that correlations between stocks and stock sectors will trend lower while the dispersion of returns increases, both of which are constructive for active portfolio management. Stock and stock sector correlation in the S&P 500 has already fallen below historical averages. As trade, tax reform and deregulation policies become clear, they will impact sectors and companies differently based on their supply chains and geographical exposures. The direction and pace of interest rate moves will also cause equity sector correlations to fall. We expect this differentiation in fundamentals to create more “winners and losers,” heightening the dispersion of equity returns further. We believe an active portfolio management strategy is best positioned to benefit in this environment.
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