Managers bullish on Canadian equities

It may be tax-loss selling season, but many investors are already looking ahead to 2010. After a 54% rise since the S&P/TSX Composite Index hit bottom in March, the easy pickings might be gone, but that doesn’t mean confidence has slumped.

The latest Russell Investment Manager Outlook survey found that 83% of professional investment managers expect additional gains on the TSX in the coming year.

“This confidence is built on a foundation of strong bank earnings, improving economic statistics, rising commodity prices and a rebounding residential real estate market,” says Sadiq S. Adatia, chief investment officer of Russell Investments Canada Ltd. “Indeed, despite continuing high unemployment numbers, Canada’s relative prosperity remains the envy of the world.”

When asked to identify the sectors they preferred, managers had an especially positive view of the energy sector with 71% saying they were bullish, compared to 14% who were bearish.

“With the shares of Canadian oil producers priced for roughly $65/barrel, the recent trading range in the area of $75-plus implies continued upside potential for the Energy sector,” Adatia says.

Financial stocks also remain favourites although sentiment declined slightly, which Adatia says may be partly a result of Manulife’s dividend cut. Still, 61% of managers were bullish, compared to 21% who were bearish.

Strong gold prices are supporting overall positive sentiment toward the materials sector, with 54% expecting growth, compared to 32% who were bearish. Adatia says that if gold were stripped out of the sector, bearishness would likely be higher.

The relatively solid dividend yield offered by the telecom sector, coupled with growth potential, boosted bullish sentiment from 48% to 52%.

“In contrast, utilities, industrials, consumers discretionary and consumer staples are traditionally considered defensive sectors with solid—if unspectacular—growth potential,” says Adatia. “This may explain why bullishness towards all four declined this quarter. In the current rising market environment, investment managers are likely finding more compelling growth opportunities elsewhere.”

In terms of market capitalization, managers expect to see large-cap stocks gain ground on the small-cap sector, which outperformed in 2009. Bullishness toward smaller companies fell from 62% of managers in the previous quarter to 47%.

This confidence in Canada appears to be well-placed. According to a report out of RBC Economics, the Canadian economy is set to grow in 2010 with real GDP rising by 2.6%, accelerating to 3.9% in 2011. That would place Canada at the front of the G7.

The U.S. economy is expected to grow by 2.5% in 2010, with growth rising to 3.4% in 2011.

The Canadian unemployment rate is expected to remain high in 2010 and average 8.7% before improving to 7.8% in 2011. Consumer spending is projected to increase by 2.3% in 2010, and 2.7% in 2011.

“With the financial crisis behind us and the U.S. economy on the mend, Canada’s economic growth is expected to rise steadily throughout the next year,” said Craig Wright, senior vice-president and chief economist with RBC. “While challenges remain, a peak in stimulus and infrastructure spending across the federal, provincial and municipal governments, along with low interest rates, should result in a sustained recovery.”

Canadian stocks are not the only ones attracting attention. Emerging market equities are expected to provide positive returns, with 64% of managers saying they are bullish. Meanwhile, sentiment toward the U.S. and the MSCI EAFE markets remains low, with 44% of managers bullish on America and 47% favouring EAFE markets.

“There is some concern that improving U.S. economic data is more a reflection of government stimulus than bona fide growth,” says Adatia. “We believe it will take until the first or second quarter of 2010 to gain a clearer picture of the state of the U.S. economy. It’s quite possible that investment managers will re-assess their outlooks for U.S. equities at that time.”

While managers are largely bullish toward equities, near-zero central bank rates have made bonds and cash far less appealing. Only 18% of managers are bullish on bonds, with cash virtually a no-go.

“At Russell, we strongly believe in the market’s long-term prospects and continue to support full participation in the markets,” says Adatia. “We share investment managers’ low opinion of holding cash and strongly recommend that investors enter the market while taking a thoughtful approach to diversification in order to mitigate risk and take advantage of critical opportunities.”

(12/14/09)