TD bets on large caps in 2006

Large cap companies are expected to squeeze out small caps in 2006, but look for a mid-cycle correction, says TD Bank in its annual investment outlook.

According to the bank, corporate earnings and equity returns are both expected to be in the mid-single digits in North America in 2006. Under these conditions, the bank foresees the U.S. central bank being “accommodative” in setting their fiscal policy, likely in response to a mid-cycle correction.

“Overall, investors can expect steady, but not spectacular progress in their portfolios in 2006,” says Bob Gorman, TD’s vice-president of managed investments.

Like many other forecasters, the bank expects rising U.S. interest rates and tighter credit availability will make it difficult for homeowners to refinance, which would be a blow to consumer spending. Last week, David Rosenberg, chief North American economist for Merrill Lynch, told a meeting of Toronto business leaders that even a flattening of the housing market in the U.S. will lower consumer spending.

Large cap defensive equities that have stable sales, earnings and dividends are seen as leading the market. Household products makers like Colgate-Palmolive and Pepsico as well as health care companies are seen as good bets in the U.S. In Canada, diversified financial institutions and insurers are viewed positively by the bank.

Indeed, the financial sector has been trading higher since the Conservative gained the lead in the polls amid speculation a Tory prime minister would be more agreeable to bank mergers.

Conversely, income trusts and the energy sector are not expected to be as hot this year. The bank cites lower crude prices in the mid-$40 range and a lower total returns from the trust sector as factors that will impact these trusts and energy companies.

Japan’s Nikkei, however, is poised to outperform U.S. equities for the third straight year according to the bank. Solid earnings growth, strong exports to China, an improving banking sector and a stronger political environment has the bank advising investors to consider increasing their Japanese exposure within their international holdings.

TD will be hoping its predictions for the year are as good as they were for 2005. The bank was only slightly off the mark in two of its six predictions. For instance, TD predicted North American Equity portfolios would generate single-digit returns. That was true of the U.S., but certainly not in Canada, thanks to an unforeseen increase in the price of oil. The bank was also slightly off on its guess that small caps would underperform large caps. In this case, the bank was right about that in Canada, but in the U.S., small cap performance was inline with the S&P 500.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(01/12/06)