Buoyed by strong performance in the energy, materials and financial sectors, the TSX continues to reach new records. Oil prices have been going higher as OPEC sees unprecedented compliance to production cuts, and major Canadian lenders are hitting all-time highs just ahead of earnings season. Things look calm in the Canadian markets right now, optimistic even.
With the resurgence in the TSX being so heavily tied to specific subsectors – materials, energy and financials - Chad Larson, Senior Vice President, Portfolio Manager at National Bank Financial, notices a similarity to what was seen in the S&P 500 Index a couple of years ago when FANG stocks (Facebook, Amazon, Netflix, and Google) played a disproportionately important role in driving growth. “If you stripped out those stocks from the S&P, the index was mostly flat, but contributions from those four companies in the tech sector drove the index up,” Larson says. “We’re seeing large contributions from energy and materials which are rising from lows, and that’s skewing investor sentiment. Indexes are great to buy, but they can be a misleading barometer for the overall strength of the economy.”
Regarding rising oil prices, Larson is cautious. Although OPEC has forced thorough some constructive cuts, members have historically not stuck to production agreements. Compliance rates may look positive at the moment, but Larson is eager to see how that plays out throughout the entirety of quarter one. “Markets do a great job of finding the silver lining but, overall, optimism is cyclical,” Larson says.
Despite the positivity in Canada, Larson believes that the S&P 500 will perform better than the TSX this year. Canada was the top performing market last year, but Larson now sees a late rally trade occurring. “When stocks do well people pile into them; it’s a function of how investors invest,” he says. “It’s a part of the euphoria trade, where people feel they can do no wrong. Although, on a fundamental basis, managers should be looking to the emerging markets and Europe to find more value.”
From an asset allocation view, Larson is currently carrying an elevated weight of cash. He does have some option strategies in place aligned with some put strategies and approximates that around 15% of his equity exposure is hedged at the moment. “I would say we’ve hedged our equity exposure to capture 80% of the upside and 50% of the downside,” Larson says. “I’m more cautious than optimistic and in any risk-reward matrix I need to make more money than I can lose, with good precision. My risk ratio needs to be positive, but right now I don’t believe that to be the case for the TSX.”
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