5 signs Canadian stocks are frothy
"The market has now outpaced most underlying fundamentals and appears to be pricing in an acceleration in global growth," says Brian Belski, chief investment strategist at BMO Capital Markets
Jonathan Ratner
The S&P/TSX composite index has risen 25% since June 2013 and has rallied in 11 of the past 12 months, but some investors are still playing catch-up and putting money into Canadian stocks, while others are taking profits.
Brian Belski, chief investment strategist at BMO Capital Markets, seems to be recommending the latter.
"The market has now outpaced most underlying fundamentals and appears to be pricing in an acceleration in global growth," he told clients, highlighting five signs of froth for the TSX.
1. Forward P/E ratios are near the highest level since 2000
"Fundamentals will need to improve drastically to justify these valuations," Mr. Belski said. However, he noted that average growth expectations for 2014 and 2015 have been cut by 0.5% and 0.3%, respectively, since 2013. As a result, the strategist believes the economic outlook does not support the move in valuations to cycle highs.
2. More than 35% of TSX companies are hitting 52-week highs
Mr. Belski noted this puts them more than 1 standard deviation above historical norms. BMO's analysis shows the TSX declines an average of 6% in the six months following such a peak.
3. Volatility is at a record low
Mr. Belski highlighted the trailing 12-month price volatility of the S&P/TSX composite as he believes this shows a "heightened level of investor complacency."
4. Stock performance is significantly outpacing underlying commodities
"Although commodity prices in Canadian dollars have been rising with an improving U.S. economy and heightened geopolitical risk, equity markets have clearly outpaced these gains," Mr. Belski said, adding that commodity price gains are key for sustainable TSX outperformance.
5. Recent TSX outperformance has been highly concentrated in energy stocks
Almost half the rally in the Canadian benchmark so far this year has been driven by the energy sector. BMO noted that 50% of the top 20 TSX performers in 2014 have been energy stocks, bringing the sector's weight back to 2011 levels.
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