Why stock market indexes are hitting record highs

With both the Dow and the TSX climbing to record highs in the middle of last week, investors are feeling optimistic, but do they have good reason?

Why stock market indexes are hitting record highs

With both the Dow and the TSX climbing to record highs in the middle of last week, it seems as though investors both in the U.S. and here in Canada are feeling optimistic. Investors on both sides of the border are counting on the Trump administration to usher in lower taxes and boost spending on infrastructure, which will stimulate the U.S. economy. Also, Trump’s greenlight to advance construction of TransCanada Corp.’s Keystone XL pipeline from Alberta’s oil sands to the U.S. Gulf Coast has given added vigor to energy stocks. Trumponomics, it seems, are in full effect.

“Most of the heavy lifting to get the TSX and Dow to those levels was done towards the end of last year in the rally post the U.S. election,” explains Chhad Aul, VP, Portfolio Manager with Sun Life Global Investments. “Since the election, two thirds of the contribution to the TSX index has come from the financial sector and that is very much down to the higher yields in the bond market and the steeper yield curve, which is very beneficial to all financials and banks in particular. That got priced in very quickly.”

In Canada, the energy sector has also continued to move in a positive direction as oil prices have gradually edged higher after the OPEC decision to cut production towards the end of last year.

The optimism around the potential for positive growth and inflation are moving yields higher, which is unwinding a drag on the financial sector in a period of loose monetary policy, low interest rates and ultra-low yields. The Trump rally has been a bit of a reversal of that.

 “There was a lot of optimism in the markets right after the election, but so far this year, it’s been kind of a slow grind higher and I would expect that to continue,” Aul explains. “There is still a fair bit of optimism about growth positive polices from the new administration but also a lot of headline risk from day to day.”

The market focused on the positives in the aftermath of the election result and, as a result, a lot of that good feeling got priced in very quickly. The markets could now be poised for a period of consolidation as investors wait to see if those assumptions that were priced in become a reality. Although there may be some pullbacks, Aul doesn’t expect them to last very long. “There is still a bit of cash on the sidelines but most investors have the mindset of wanting to put that cash to work,” he says. “We are due for a little bit of a correction, but I also feel it will be quite short-lived because a lot of market participants do have some cash and are waiting for an opportunity.”

With regard Canadian equities, Aul and his team have been bullish on the energy sector for the last 18 months or so, a strategy that has worked out quite well. They have been underweight most other sectors, on the back of concerns over the domestic economy, but have gone positive on financials since the election. “Interest rates and yields are still far from normalized at this point so there is still room for financials to do well,” Aul says. “We’re still concerned with the more domestically oriented sectors of the Canadian equity market because those risks are still high with an over indebted consumer and inflationary housing market. A bar bell strategy is how I would describe our approach to Canadian equities.”

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