Download October 2, 2012 Global equity markets generally performed well in

October 2, 2012
Global equity markets generally performed well in the third quarter, despite some continuing
macro-economic headwinds. The Canadian S&P/TSX Composite Total Return Index generated a
return of 7.0% in the quarter and the US S&P 500 Total Return Index produced a 6.4% return.
By comparison, bond returns were generally relatively flat.
This trend of headline macro-economic risks and positive longer-term equity performance may
continue for some time. There is little doubt that the economic recovery since the 2008/09
recession has been very gradual and below expectations. However, over the last three years the
Canadian and US equity markets have generated positive annual, compound total returns of
5.5% and 13.2% respectively.
Our view is that equity investors have generally been discounting (expecting) very little
economic growth and possibly even a mild recession? As a result, even tepid GDP and corporate
earnings growth results are meeting or beating investors’ expectations. However, positive
earnings growth and several years of decent market performance haven’t allowed investors to
forget the carnage of 2008/09.
Retail fund flows into equities continue to be light. What little money is being directed to
equities tends to be in balanced or dividend funds. Even professional strategists are bearish.
Among Wall Street strategists, the recommended stock weighting is 44%. This compares to a
long-term average of over 60%. As Tom Bradley, President of Steadyhand Investment Funds Inc.
points out, “when everyone is bearish the downside risk is more limited because most of the
distressed selling has been done”. Bearish sentiment, even among strategists, is a very bullish
indicator.
The macro-economic headwinds include a slow resolution to the European debt crisis, the
gradual de-leveraging of U.S. governments and consumers and a slowdown in economic growth
in China. Both the European and U.S. situations are going to require austerity in some form to
be resolved. The implications of debt de-leveraging are not positive for robust economic
growth. Any combination of tax increases and spending reductions will be a drag on GDP
growth. These changes are going to be unpopular and take a long time. Investors will likely
have to get used to slower growth than we have become accustomed to.
Again, the good news for investors is that this scenario seems to be what the market is
discounting. Despite alternative asset classes like bonds and real estate trading at historically
high valuations (low yields), stocks are trading at attractive valuation levels.
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The charts below show that the Canadian market is trading below the long-term average of both
trailing and forecast earnings. Forecast earnings have also recently begun to be revised
upwards, an unusual situation which again indicates that even modest economic growth is
exceeding market expectations.
TSX P/E Multiple
Based On Trailing Operating Earnings
40
Median: 16.7
Average: 17.0
40
35
35
30
30
25
25
20
20
15.2
15
15
10
10
5
5
0
0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
M11
OCT 2012
TSX Price-Earnings Multiple
Based on 12 Month Forward Operating Earnings
26
Median: 15.0
Average: 15.1
26
24
24
22
22
20
20
18
18
16
16
14
13.8
14
12
12
10
10
8
8
88
90
M2050
Source: TD Securities Inc.
92
94
96
98
00
02
04
06
08
Bottom Up Earnings Based on CPMS Consensus
10
12
14
OCT 2012
The slowdown in growth in China has reinforced our view of maintaining only a modest
weighting in Materials. Many commodities have traded above their long-term average prices
(and above their marginal cost of production) for many years, largely in anticipation of an
insatiable appetite for natural resources in China. Economic growth in China hasn’t ground to a
halt, but expectations may need to be recalibrated.
The Canadian economy and stock market have many redeeming features other than abundant
natural resources. We are finding compelling investment opportunities in the Consumer,
Industrial, Technology and Financial Services sectors. We continue to believe that patient,
equity investors will be rewarded.
Warmest Regards,
The Seymour Team