If you’re keeping track of the ongoing rally for the S&P 500, you’ll know that the index has gone 318 days without a correction of five per cent or more. That makes this the longest such run since 1960.
While that may make some investors nervous considering the S&P 500 continues to hit fresh all-time highs, there is at least one good reason why a sharp pullback or lengthy retreat doesn’t appear to be on the horizon.
Stéfane Marion, chief economist and strategist at National Bank Financial, highlighted the equity risk premium — the spread between the return on stocks and that of risk-free investments such as U.S. Treasury bonds. That’s largely because long-term treasury yields are rising rather slowly, as inflation remains low.
Not only does this market measure look attractive by historical standards, but there is good reason to believe U.S. economic growth will recover from the damage inflicted by major storms.
“Though economic growth may have been softened a bit in the third quarter by hurricane disruptions, the U.S. did not sustain long-term damage to its industrial plants,” Marion said. “Economic growth should thus bounce back fairly quickly, as we have seen with the beginning of reconstruction.”
The strategist noted that the earnings outlook could get a boost from Washington’s proposed cut to the basic corporate tax rate, as well as a one-time repatriation tax holiday. In an effort to bolster growth, a White House plan to provide tax relief to the middle class may also provide a lift to earnings.
“So for now, the U.S. stock market seems to be enjoying some continuing tailwinds,” Marion said. “Though normalization of monetary policy is an element of risk, there is some way to go before it reaches a point that could be called restrictive.”
Expectations for tax stimulus have also pushed the Dow Jones Industrial Average, Nasdaq, Russell 200 and NYSE composite to record highs, but David Rosenberg isn’t all that optimistic.
The chief economist and strategist at Gluskin Sheff + Associates acknowledged that market breadth is currently a promising indicator (the NYSE advance/decline line continues to trend higher), and the overall technical backdrop for stocks has improved. However, he said “there is not a snowball’s chance in hell” that fiscal hardliners in the Republican party will pass a tax bill that leaves a massive hole in the U.S. budget.
He also noted that three-quarters of the gains in the ISM Purchasing Managers Index was attributable to the two recent hurricanes that hit the U.S.
When it comes to market volatility, Rosenberg pointed out that only twice has it been this low. The VIX recently closed at its fifth lowest level ever, and stocks have only been this expensive 10 per cent of the time on record, yet new highs continue to be made.
“Worth keeping this in mind as the market narrative has swing massively bullish,” the strategist said.
The Canadian stock market isn’t nearly as strong as its U.S. counterpart, but the S&P/TSX Composite Index is making a comeback. September’s 2.8 per cent gain was the strongest performance in 14 months, and the index’s year-to-date return is now in positive territory (up more than two per cent).
“We see further upside for the S&P/TSX ahead,” Marion said, pointing to brisk Canadian economic growth, strong employment trends, robust wage and salary gains, and pre-election spending in several provinces coming in January 2018.
The strategist also note that S&P/TSX earnings revisions have turned positive, whereas S&P 500 have shifted slightly downward. In Canada, the upward revisions have occurred in seven of the 11 main sectors.
However, the primary reason Marion prefers Canada over the U.S. is because of valuation, as the S&P/TSX is trading at a significant discount to the S&P 500.
He recommends an overweight in financials, as the sector should benefit from rising interest rates in a strong Canadian economy.
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