Financial Post - Article by Jonathan Ratner published January 13th, 2009
Earnings generated by companies in the S&P/TSX composite index will decline 7.5% in 2009, their lowest level of annual growth, and things might still get worse, some strategists say.
But almost all strategists agree that stocks have rarely been cheaper.
Robert Buckland, Citigroup's chief global equity strategist, said we are only a quarter of the way into an anticipated 50% peak-to-trough decline in earnings deterioration, adding that consensus bottom-up forecasts are probably 30% too high for 2009. Earnings pre-announcements are also starting to worry investors.
Nonetheless, after the worst year since 1931, Mr. Buckland said he thinks global equities look cheap in absolute terms and even more attractive against defensive assets like government bonds.
George Vasic, a strategist at UBS, insists that valuations have fallen too far.
"Overall, we think investors under-appreciate the extent to which valuations have plunged, and the depths at which they currently reside," he told clients, noting that both trailing and forward price-to-earnings multiples have declined about 40%. This is more than during the technology bust and the 1994 doubling of interest rates.
Mr. Vasic also pointed out that PEs are at their lowest levels since 1988, when corporate and government bond yields were 11% and 10%, respectively, compared to 7.5% and 3% today. Even if earnings fall by a third, he estimates that the implied TSX level would be at least 12,000.
Martin Roberge, a Dundee Securities strategist, said "relative to bonds, equities just experienced their worst 10-year stretch, which should trigger tactical tilts and the rebalancing of strategic asset mix benchmarks toward equities."
If asset mixers are to favour bonds versus equities, they must have a strong conviction that vast amounts of global monetary and fiscal stimulus will fail, he added.
Dundee's Mr. Roberge said conditions for a cyclical rally that could push indexes as much as 50% above November lows sometime in the first half of the year are starting to build. At the same time, if global fiscal and monetary policy fails to stop the slide of the U. S. and global economy, he warned that the worst-case scenario for equity markets could be 6200 for Canada's benchmark index.
Chad McAlpine, RBC Capital Markets quantitative analyst, said index earnings in Canada are not only at a historic high but they are approaching a major peak -- a bearish sign for earnings growth, as forecasts only approach negative territory near major cyclical earnings peaks.
"When 12-month earnings growth expectations have reached their lowest levels during past major earnings cycles, two years of poor market performance has followed," he warned.
However, each of these two-year windows had a four to six-month rally in the first year before the market dropped to a pre-recovery low. So opportunities exist for those who are successful at timing the market.
Despite the gloomy outlook, there are some TSX sectors with a positive outlook. They include health care, consumer staples, industrials and utilities.
In its 2009 look-ahead, RBC Capital Markets warned that "downside forces for equities could resurface if the authorities fail to arrest the economy's gathering deflationary tendency."
To call a meaningful turn in global equities, Citigroup thinks we need to be closer to the bottom in the corporate earnings cycle. Its forecasts suggest that is more likely to happen in 2010, while 2009 may be a trading range year.
"So don't sell after a 30% fall and don't buy after a 30% rally."
Barry Knapp, a Barclays Capital strategist, said in a note that he thinks the cycle low is ahead of us, not behind us.
"So, keep your powder dry ... the opportunity to get long equities for a second half economic recovery should develop later in the quarter."