January 2017

Highlights 

At this writing the S&P 500 is up 6.1%, making the Trump rally the second-best on record after Lyndon B. Johnson’s swearing-in of November 1963. Meanwhile, bonds of major-economy governments continue to sell off.



The stock market could move still higher, though the S&P 500 is far from cheap currently at more than 20 times trailing earnings. At that kind of multiple, the market driver will need to be earnings growth rather than P/E expansion. After all, when the Fed is tightening, a P/E contraction is the norm.



Canadian equities are ending the year in strength, on track for an annual total return exceeding 20%. This performance, the best in seven years, makes Canada one of the global top performers in 2016. Such a feat is unlikely to be repeated in 2017.



At this juncture we continue to recommend an asset mix tilted towards equities and away from bonds. We continue to expect the 10-year U.S. Treasury yield to converge on its fair value, which we estimate at 2.8%.

Stéfane Marion [email protected]

Matthieu Arseneau [email protected]

MONTHLY EQUITY MONITOR The Trump rally continues

World: Bond yields now positive in all of the major economies

Global equities continue to do exceptionally well in the wake of the U.S. election. At this writing the S&P 500 is up 6.1%, making the Trump rally the second-best on record after Lyndon B. Johnson’s swearing-in of November 1963 (chart).

4.4

Yield of 10-year government bond: U.S., Japan and Germany %

4.0 3.6 3.2 2.8 US

2.4 2.0 1.6

The S&P 500 and new presidents

1.2

Change in the U.S. stock market in the first 31 trading days after announcement of a new president 15.0

0.8

%

9.6

10.0 5.0 2.0

0.8

2.0

3.0

2.8

4.4

5.8

6.1

-11.7

JP

-0.4 2009

2010

2011

2012

2013

2014

2015

2016

2017

Upside surprises in the Chinese, U.S. and Eurozone economies; expectations of Fed tightening; a new agreement for oil production cuts that includes nonOPEC members; potential fiscal stimulus in the U.S. – all of these are likely to remain headwinds for the global bond market in the coming months.

-5.0

-15.0

GY

0.0

NBF Economics and Strategy (data via Datastream)

0.0

-10.0

0.4

-10.1

-14.1

-20.0

NBF Economics and Strategy (data via Bloomberg)

World: Best crop of major-economy upside surprises since 2013 Citi Economic Surprise Indexes

This performance has been led by a spectacular 21.2% jump of Financials in Q4 to date (table). Industrials, Energy and Materials are also posting hefty gains.

80

Index Eurozone

60 40

US

20

China

0 -20

S&P 500 composite index: Price Performance Month to date

Quarter to date

Year to date

S&P 500

2.7

4.1

10.5

TELECOM

6.1

1.7

15.7

-40 -60 -80

UTILITIES

4.4

-1.0

11.9

-100

FINANCIALS

4.3

21.2

20.8

-120

CONS. STAP.

3.7

-1.9

3.4

-140

ENERGY

3.4

8.2

25.6

REAL ESTATE

3.0

-6.0

-0.8

IT

2.5

1.7

13.0

HEALTH CARE

1.7

-3.4

-3.3

CONS. DISC.

1.6

3.6

6.1

MATERIALS

1.5

5.8

15.9

INDUSTRIALS

1.0

7.3

16.8

12/16/2016 NBF Economics and Strategy (data via Datastream)

Meanwhile, bonds of major-economy governments continue to sell off. For the first time in almost a year, bond yields have turned positive in Japan and Germany (chart). This is what you call a regime change.

2013

2014

2015

2016

2017

NBF Economics and Strategy (data via Bloomberg)

Market expectations for U.S. monetary policy have changed quite dramatically since the September FOMC meeting. As the chart below illustrates, the market now sees two rate hikes in 2017. As for 2018 and 2019, the investor community remains much less aggressive about rate hikes than the FOMC, but that could change as the size and nature of the U.S. fiscal stimulus package become clearer.

2

MONTHLY EQUITY MONITOR S&P 500 composite index: EPS Performance

S&P 500 ENERGY MATERIALS INDUSTRIALS CONS. DISC. CONS. STAP. HEALTH CARE FINANCIALS IT TELECOM UTILITIES REAL ESTATE 12/16/2016

2015

2016

2017

2018

0.3 -61.3 -5.3 3.0 14.2 0.1 11.5 12.5 7.8 11.8 -0.1 NA

1.2 -76.9 -2.5 1.2 11.8 4.5 8.3 1.1 4.7 0.7 5.5 NA

11.4 344.4 15.0 3.7 9.1 6.8 8.6 10.8 11.4 3.3 0.3 NA

11.8 47.9 5.9 11.5 13.0 8.4 9.6 10.9 11.3 4.1 6.0 NA

12 forward growth 11.5 344.8 15.6 4.3 9.2 7.0 8.6 10.8 11.1 3.3 0.3 #VALUE!

NBF Economics and Strategy (data via Datastream)

Against this backdrop, we continue to expect the 10year U.S. Treasury yield to converge on its fair value, which we estimate at about 2.8% (see our Fixed Income Monitor for more detail). If this rise of yields is accompanied by a little more inflation (and assuming that we avert China-U.S. trade tensions), the stock market could move still higher, though the S&P 500 is far from cheap currently at more than 20 times trailing earnings. At that kind of multiple, the market driver will need to be earnings growth rather than P/E expansion. After all, when the Fed is tightening, a P/E contraction is the norm (chart).

There is a fair chance that this target will be reached, if fiscal stimulus and regulation rollback entice business and confident consumers to spend more. The U.S. savings rate is quite high and the unemployment rate is below 5%.

S&P 500: P/E contraction is the norm when the Fed tightens S&P 500 ratio of price to trailing earnings vs. federal funds rate 150 %

Ratio

100

S&P 500 P/E (R)

50 35 25 15 10

22 20 18 16 14 12 10 8 6 4 2 0

5

Fed funds rate (L)

1975

1980

1985

1990

1995

2000

2005

2010

2015

Canada: Best performance in 7 years Canadian equities are ending the year in strength, on track for an annual total return exceeding 20%. This performance, the best in seven years, makes Canada one of the global top performers in 2016.

NBF Economics and Strategy (data via Datastream)

As of December 16, the bottom-up consensus of equity analysts sees earnings growth of 11.4% in 2017 (table).

3

MONTHLY EQUITY MONITOR MSCI composite index: Price Performance (Total return) Month to date

Quarter to date

Year to date

2.8

4.5

10.0

MSCI World

3.2

5.3

10.1

MSCI USA

2.7

4.4

12.5

MSCI Canada

1.5

5.5

21.1

MSCI Europe

4.9

4.6

7.0

MSCI Pacific ex Jp

-0.1

0.3

7.4

MSCI Japan

5.7

17.6

1.8

MSCI AC World

MSCI EM

-0.6

-2.1

9.2

MSCI EM EMEA

3.0

1.8

10.7

MSCI EM Latin America

-3.3

-0.9

21.9

MSCI EM Asia

-0.8

-3.2

7.0

times forward earnings. Second, the forward earnings in the denominator of that ratio incorporate rather aggressive earnings growth of 25.5% in 2017. As the table below shows, that growth expectation depends mainly on earnings in Energy (+602%) and Materials (+59%), meaning that much of the good news is already reflected in stock prices. S&P/TSX Composite Index: EPS performance

2015

2016

2017

2018

12 forward growth

S&P TSX

-17.4

-1.8

25.5

13.2

25.9

ENERGY

-87.4

-36.7

601.9

44.4

601.9

MATERIALS

-46.6

48.6

59.0

8.7

60.1

INDUSTRIALS

15.4

-11.4

11.8

14.9

11.7

CONS. DISC.

29.3

3.0

13.4

13.8

12.5

S&P/TSX: Best performance in seven years

CONS. STAP.

10.6

14.9

14.4

9.6

13.1

Annual total return

HEALTH CARE

26.4

-54.2

0.8

16.1

0.8

FINANCIALS

1.6

-0.3

8.2

7.5

8.4

BANKS

5.9

4.0

4.6

6.6

5.0

28

IT

5.6

11.5

12.4

10.1

12.4

24

TELECOM

-0.6

7.8

5.9

5.5

5.9

UTILITIES

38.8

28.2

0.9

10.7

5.0

NA

NA

NA

NA

#VALUE!

12/16/2016 NBF Economics and Strategy (data via Datastream)

36 32

%

20 16 12 8

12/16/2016

4 NBF Economics and Strategy (data via Datastream)

0 -4 -8 -12 -16 -20 -24 -28 -32 -36 2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016 *

* Through December 16 NBF Economics and Strategy (data via Datastream)

Banks, Energy and Materials led the S&P/TSX outperformance with gains exceeding 30% (chart). S&P/TSX composite index: Price Performance (Total return) Month to date

Quarter to date

Year to date

1.3

4.1

20.6

S&P TSX

For example, the commodity-price assumptions used by equity analysts to derive profit expectations include WTI oil at US$58 a year from now. That may not seem unreasonable given the recently announced intention of OPEC and Russia to reduce their crude production, but uncertainty remains about the outlook for North American production. Canadian oil output has picked up notably since the Alberta wildfires and U.S. output has risen by almost 300,000 barrels a day in recent weeks (chart). U.S.: Crude oil production is accelerating

5.2

13.1

30.8

9.7

FINANCIALS

4.0

12.1

24.7

9.6 4-week moving average

CONS. DISC.

3.6

3.3

12.7

9.5

ENERGY

2.4

8.1

36.9

9.4

UTILITIES

2.0

-1.3

16.6

9.3

REAL ESTATE

0.8

-2.6

6.1

9.2

TELECOM

0.6

-3.9

13.4

9.1

CONS. STAP.

0.2

-1.1

7.9

9.0

INDUSTRIALS

-0.8

5.1

22.5

8.9

BANKS

IT

-1.9

-1.4

4.3

8.8

MATERIALS

-6.3

-11.5

33.2

8.7

-11.2

-33.2

-79.8

8.6

HEALTH CARE 12/16/2016

Millions of barrels per day, Output is up more than 276,000 BpD so far in Q4 …

… the first notable increase since mid-2015

8.5

NBF Economics and Strategy (data via Datastream)

8.4 2014Q2 2014Q3

Such a feat is unlikely to be repeated in 2017. First, the S&P/TSX is already trading at more than 16.3

2014Q4

2015Q1

2015Q2

2015Q3

2015Q4

2016Q1

2016Q2

2016Q3

2016Q4

NBF Economics and Strategy (data via EIA)

4

MONTHLY EQUITY MONITOR Asset allocation

Sector rotation

At this juncture we continue to recommend an asset mix tilted towards equities and away from bonds. We continue to expect the 10-year U.S. Treasury yield to converge on its fair value, which we estimate at 2.8%. To the extent that the rise of yields is accompanied by a little more inflation and China-U.S. trade tensions are averted, the stock market could move still higher, though the S&P 500 is certainly not cheap at 17.1 times forward earnings.

Our sector rotation remains unchanged this month with a bias toward banks and an underweight stance on energy – the two main sectors of the S&P/TSX. Our expectation of a slightly stronger U.S. dollar coupled with rising oil supply in the U.S. leads us to think that crude oil prices have peaked for the time being. We expect bank stocks, on the other hand, to continue benefiting from a steeper yield curve and reform of the Dodd-Frank Act governing U.S. financial institutions.

Canada: Total return of asset classes so far in Q4 To December 19, 2016 – in CAD

NBF Asset Allocation Benchmark NBF Change (pp) (%) Recommendation (%)

6.4

S&P 500

Equities Canadian Equities

4.1

S&P/TSX

U.S. Equities

0.0

MSCI EAFE

Foreign Equities (EAFE)

-3.4

MSCI EM

20

20

21

5

Emerging markets 5 45 Fixed Income 5 Cash 100 Total NBF Economics and Strategy

0.1

CASH

20

5 5 39 10 100

-4.3

FTSE TMX

%

-6

-4

-2

0

2

4

6

8

NBF Economics and Strategy (data via Datastream)

5

MONTHLY EQUITY MONITOR NBF Market Forecast

NBF Market Forecast

Canada

United States

Index Level S&P/TSX

Actual

Q42017 (Est.)

Dec-21-16

Target

15,306

15,600

S&P 500

Q42017 (Est.) 855 484 18.2 Q42017 (Est.) 0.63 2.14

Assumptions

Assumptions Level:

Earnings * Dividend

PE Trailing (implied) Treasury Bills (91 days) 10-year Bond Yield

741 419 20.6 0.49 1.80

* Before extraordinary items, source Thomson

Actual Index Level

Level:

Earnings * Dividend

PE Trailing (implied) Treasury Bills (91 days) 10-year Bond Yield

Q42017 (Est.)

Dec-21-16

Target

2,265

2,340

117 46 19.3 0.51 2.54

Q42017 (Est.) 127 50 18.4 Q42017 (Est.) 1.05 3.03

* S&P operating earnings, bottom up.

NBF Economics and Strategy

6

MONTHLY EQUITY MONITOR NBF Fundamental Sector Rotation - January 2017 Name (Sector/Industry)

Recommendation S&P/TSX weight

Energy Energy Equipment & Services Oil, Gas & Consumable Fuels

Underweight Underweight Underweight

21.6% 0.7% 20.9%

Materials Chemicals Containers & Packaging Metals & Mining * Gold Paper & Forest Products

Market Weight Underweight Market Weight Market Weight Market Weight Overweight

11.2% 2.3% 0.5% 8.0% 5.2% 0.5%

Industrials Capital Goods Commercial & Professional Services Transportation

Market Weight Overweight Underweight Market Weight

9.0% 1.9% 1.6% 5.5%

Consumer Discretionary Automobiles & Components Consumer Durables & Apparel Consumer Services Media Retailing

Underweight Underweight Overweight Underweight Market Weight Underweight

5.1% 1.3% 0.5% 1.0% 1.1% 1.2%

Consumer Staples Food & Staples Retailing Food, Beverage & Tobacco

Underweight Underweight Underweight

3.8% 3.0% 0.8%

Health Care Market Weight Health Care Equipment & Services Market Weight Pharmaceuticals, Biotechnology & Life Sciences Market Weight

0.6% 0.2% 0.4%

Financials Banks Diversified Financials Insurance

Overweight Overweight Market Weight Overweight

35.4% 24.1% 4.1% 7.1%

Information Technology Software & Services Technology Hardware & Equipment

Overweight Overweight Market Weight

2.7% 2.3% 0.4%

Telecommunication Services

Market Weight

4.8%

Utilities

Market Weight

2.8%

Real Estate

Market Weight

3.0%

* Metals & Mining excluding the Gold Sub-Industry.

7

MONTHLY EQUITY MONITOR ECONOMICS AND STRATEGY Montreal Office 514-879-2529 Stéfane Marion

Marc Pinsonneault

Chief Economist & Strategist

Senior Economist

Kyle Dahms Economist

[email protected]

[email protected]

[email protected]

Paul-André Pinsonnault

Matthieu Arseneau

Angelo Katsoras

Toronto Office 416-869-8598 Warren Lovely

Senior Economist

Geopolitical Analyst

MD, Public Sector Research and Strategy

[email protected]

[email protected]

[email protected]

Senior Fixed Income Economist

Senior Economist

[email protected]

[email protected]

Krishen Rangasamy

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