By: Jeff Pollock
December 14, 2017
With just over two weeks left to go in the 2017 calendar year, the market has been kind to optimists while painful for pessimists.
Up until the end of September, Toronto had largely been flat before roaring back into positive territory. Meanwhile, south of the border, the S&P 500 continues to touch new highs.
Despite the gains over the past 22 months, our outlook for 2018 is positive for equity markets for these several reasons listed below.
First, corporate and government bonds are (and have been for a decade) unattractive. They offer meagre yields in the 2.0% to 2.5% range. The traditional rule of thumb was to allocate your portfolio with equities equal to one hundred percent minus your age, and then the balance should be invested in fixed income. Investors and money managers must allocate their cash somewhere, and few see the bond market as an attractive venue to do so. (For the record, Vestcap’s Investment Committee hasn’t bought a single government or corporate bond for years, and we have no plans to do so any time soon.)
Second, economic growth isn’t just positive but its also surprising to the upside. The Citigroup Economic Surprise Index – a widely followed indicator that tracks how actual economic data compares to the expectations from economists – sits at the highest level now since 2010. ISM figures have been over 50 (indicating manufacturing expansion) all year, monthly job gains continue to track over 200,000, and retail sales are positive.
Third, earnings and revenue growth for Q4-2017 are projected to be +10.6% and +6.6%, respectively. If achieved, this will mark three out of the past four quarters where earnings growth has come in at a double-digit rate. Though estimates generally get marked down over time, the current estimate for 2018 earnings growth is projected to be +11.2%.
Fourth, valuations are admittedly high relative to historical valuations, but we think this nevertheless makes sense given the low yield bond environment. The S&P 500 is trading at 18.3x next year’s earnings, well above its 15.8x average over the past five years. However, as mentioned above, given the lack of liquid asset classes to invest in, an elevated price-to-earnings ratio is justified in our view. In case you were wondering, the P/E ratio for the S&P 500 back in 1999 before the “dot com” bubble burst was 32.9x.
For these reasons, Vestcap’s Investment Committee remains constructive on the equity market heading in to 2018. There are stocks we would clearly avoid given their parabolic price appreciation in recent months. However, we believe 2018 will be a stock pickers market and our attention has been focused on the securities that were largely ignored by investors this year. Undoubtedly, it has been more difficult finding stocks with inexpensive valuation characteristics today compared to two years ago. We’ve had to spend far more time finding these kinds of undervalued securities. Nevertheless, opportunities are emerging from our research and we continue to look for bargains for our clients.
This Blog is made available for general information purposes only. The information provided is believed to be reliable and accurate at the time it is posted. However, Vestcap Investment Management Inc. does not guarantee that the information is accurate, complete, or current at all times. The information is not intended to constitute financial, accounting, legal, insurance or tax advice and, should not be relied upon in that regard. You should consult with a professional prior to acting on any information.