The bull market in U.S. stocks, which began in March 2009, has largely proceeded in two distinct phases. The first phase was from 2009 to 2011, when the advance in prices was driven by earnings growth.  Resource stocks were the leader during this phase and Canadian stocks lead U.S. stocks as commodity prices rose, earnings recovered and stocks bounced off their extremely oversold levels from 2008.  The second phase began in the 2nd quarter of 2011 and lasted until June of this year. During this stage, stock prices have risen much faster than earnings.  Investors were uncomfortable with the outlook for global economic growth as the Euro-crisis and worries about a ‘hard landing’ in China destroyed investor confidence.  Since interest rates were so low though, and investors had very few alternatives to stocks they put money into very defensive, higher yield stock groups (REITs, telecom, consumer staples, utilities) where global growth was less of a concern.  This drove the valuation of those sectors to record levels while cyclical (growth-oriented) stocks languished. Put simply, equity multiple expansion was been the main driving force behind the 2012-2013 bull market. 

This divergence is shown in the chart below, where we see a period when low volatility, low ‘beta’ stocks (like the defensive groups described above) outperformed cyclical growth stocks.  This coincided with one of the worst two-year periods for the relative performance of Canadian stocks in years.  This period appears to have ended in June as Canadian resource stocks have recovered sharply from those lows as global growth expands.  We believe that we are still early in this new growth phase and that Canadian stocks deserve to be over-weighted .  If global investors come to the same conclusion, there could be some substantial upside for our market still.Canada lagging performance reversing?

Going forward, while stocks are no longer historically cheap, the driver of stock market gains should once again be earnings growth.  The Fed’s decision not to taper its asset purchases this month was a surprise to the marketplace. This ‘inaction’ clearly indicates that the central bank wants to protect growth, encourage risk-taking and, in effect, promote higher asset prices.  That action should support higher stock market multiples.  Bottom line is that higher earnings and the maintenance of higher valuations should support stronger stock prices over the expansion we are expecting over at least the next two years.

The “mini-stimulus” unveiled this summer by the Chinese government has hit its target with better than expected economic data pointing to modest rebounds in everything from manufacturing to electricity consumption and railway freight.  China’s industrial output increased 10.4% year-on-year in August, a 17-month high and up from a 9.7% pace a month earlier.  With retail sales, investment and exports all strong, the world’s second-largest economy has closed the books on a shaky half year and is now in recovery mode.  For those who are skeptical about the ‘official’ numbers released in China, we have also seen verification from the hard data collected on China by outside groups.  China’s imports of copper, iron ore and crude oil were up 8.9%, 10.5% and 16.5%, respectively, year-over-year in August.  Exports overall grew 7.2% and imports rose 7.0%, solidifying the idea that Chinese economic growth has clearly seen its lows for now and is stabilizing in the 7.5% annual range.

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