The year came in like a lion on the world’s equity markets. At this writing the MSCI All Country World index is up 4.4% from the beginning of the year. The gains in the advanced countries were especially sparkling -- 5.3% for the Europe index, 4.8% for North America.
- The U.S. fiscal agreement, which likely headed off a recession, has of course brought some relief. Central banks continue to provide ample liquidity and economic indicators remain by and large consistent with global growth in the 3.0-to-3.5% range.
- Recent weekly inflows to U.S. mutual funds suggest that retail investors are finally taking an interest in the stock market. In early January, net weekly inflows to equity funds were the largest since the early 2000s.
- The improving balance sheets of U.S. households also argue for a little more risk-taking in 2013. With interest rates set to stay low for the foreseeable future, households have some leeway to borrow more in the coming quarters, especially since U.S. employment growth has shifted from part-time to full-time jobs. The revenue outlook for U.S. corporations is relatively upbeat.
- However, the current advance in stock market is primarily due to a growing appetite for equities rather than to improvement of the earnings backdrop. Over the last month, analysts have continued to revise down their estimates of forward net earnings. In our view, earnings will remain subject to downward revision in the coming months as a result of margin compression. At this writing, all but two of the 10 main industry groups of the S&P 500 show a deterioration of profitability.
- That said, the tame inflation backdrop remains conducive to central bank intervention. As a result, we see the equity risk premium shrinking further in the coming months. We are accordingly raising our year-end target for the S&P 500 to 1575 (from 1450). For the S&P/TSX we now see 13,220 (up from 12,500). These new targets imply that the U.S. and Canadian equity benchmarks will trade at 14.7 and 15.0 times trailing earnings respectively.
- We have made no changes to our asset allocation this month. We remain comfortable with our benchmark recommendation of 55% equities and 40% fixed income.