Crude awakenings: stabilizing oil unlikely to improve the TSX’s performance in 2018

TORONTO — While stabilizing oil prices helped Canadian equities break out of their doldrums in the second half of 2017, investors expecting the Toronto Stock Exchange to catch up with its outperforming global peers in the new year should instead anticipate more modest returns with the add-on of greater market volatility.

“Despite being flat in the early part of the year and then posting some gains here in the back half of the year, the swings in equity prices on the S&P/TSX composite index have been incredibly small by historical standards,” said Craig Fehr, a Canadian markets strategist with Edward Jones. “And so I think the first thing we can expect from the TSX is much bigger swings in prices, much more volatility on a daily and weekly basis.”

“All that said, I think there’s still more gas left in the tank for this bull market,” he added, referencing the eight-plus years of global gains since the dark days of 2009 in the wake of the last recession. “I think we can see positive returns again in 2018. I would expect them to be relatively muted so … Canadian equities, domestic equities, still underperform international markets.”

After hitting a record high of 15,922.67 on Feb. 21, the TSX steadily declined to a low of 14,951.88 by Aug. 21, down 2.2 per cent on the year at the time. A resurgence in oil — which saw crude prices rally from a 2017 low of US$42.53 per barrel on June 21 to a barrier-breaking high of US$60.42 on the final trading day of the year — sparked a surge in energy shares that saw the TSX complete its first of many record closes in the latter half of 2017. By Dec. 27 and Dec. 28, the TSX closed at consecutive record highs of 16,203.13 and 16,221.95, respectively. It finished 2017 at 16,209.13, ahead 921.54 points or about six per cent on the year.

By comparison, Wall Street’s S&P 500 index — the American equivalent to the TSX — gained 434.78 points or about 19 per cent in 2017. The Dow Jones industrial average added 4,956.62 points or about 25 per cent, and the Nasdaq composite index gained 1,520.27 points or about 28 per cent.

One the most dominant themes in equity markets in 2017 was the trend toward stability from cyclicality in an otherwise uncertain political and geopolitical backdrop, said Candice Bangsund, vice president and portfolio manager at Fiera Capital. This saw the more defensive U.S. equity markets, which are heavily weighted towards technological growth, thrive last year. Meanwhile, the cyclically-based Canadian equity markets made up primarily of financial, energy and materials sectors were largely underappreciated.

While oil is a key influence on the commodity-heavy TSX, economist Todd Mattina of Mackenzie Investments said he expects it to remain range-bound around its current level of US$50 to US$60 a barrel going into the new year — a level that will not really help the index in a meaningful way.

“The TSX has benefited in recent months because of the strong rally in oil prices. But there’s a number of uncertainties going into 2018 that also cloud the outlook,” he said. “One of them is how much further can oil prices rally? … To the extent that higher oil prices since September have supported gains in the TSX, a risk factor in 2018 is that oil prices could run into resistance if U.S. shale producers increase production at today’s higher price levels.”

Still, oil only touches upon one of several possible risks for the TSX in 2018, Mattina added. “The oil price outlook is not the driver of our bearish view of Canadian stocks. We are underweight the Canadian stock market because valuations are not highly attractive relative to other major stock markets and our indicators of investor sentiment look bearish.”

He said that in addition to the policy uncertainty around ongoing NAFTA renegotiations, another factor weighing on the TSX is the perennial concern about very high levels of Canadian household debt and how that will affect consumer spending in the forthcoming years. Statistics Canada reported in December that household credit market debt as a proportion of household disposable income increased to 171.1 per cent in the third quarter of 2017, up from 170.1 per cent in the second quarter. That means there was $1.71 in credit market debt, which includes consumer credit and mortgage and non-mortgage loans, for every dollar of household disposable income.

While consumers were the dominant engine behind growth last year amid solid employment gains, Bangsund said she expects trade and business development to take the baton in 2018 as earlier fears of a U.S. and global economic slowdown have proven unfounded in 2017. That could see the cyclical segments of the market that favour Canadian equities regain leadership performance.

“The TSX will be the main beneficiary if that scenario of stronger growth and rising commodity prices does continue into 2018 due to that cyclicality of the Canadian stock market,” she said.

A 2018 global market outlook report by Russell Investments Canada Ltd. also supports higher Canadian equity prices due to late-cycle tailwinds while still cautioning that it also expects volatility to be higher over 2018 versus 2017 as markets start to consider the timing of the next recession. Given this uncertainty around the domestic equities, the Russell report concluded it’s “modestly positive on Canadian equities with a price target of 16,900 for year-end 2018 for the S&P/TSX composite index.”

Should Canadian equity returns in 2018 mirror those of the prior 12 months, Fehr said investors should keep in mind that while that doesn’t stack up well against the juggernaut momentum seen in other global markets, they are still relatively healthy gains.

“For the Canadian market by historical standards it’s certainly solid,” he said. “It’s underperformance but it’s positive performance, so it’s not terrible.”

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