The following commentary is courtesy of Cardinal Capital Management Inc., the sub-advisor for the VPI Canadian Equity Pool and the VPI Canadian Income Pool. The opinions, market outlook, and asset allocation strategies are those used in the design of the mutual funds they manage that we utilize in client portfolios.
During the last month the S&P500, the broad U.S. market index, set a number of new records as it plodded steadily higher. The Dow 30 has followed suit. The S&P/TSX in Canada, by contrast, with its dominance in Energy, Financials and Materials, is still below its 2007 highs. Are we too late to invest in the U.S.? Should we brace for a Crash? What is the Market telling us? The short answer to this last question is “Nothing”. Markets will go up as long as more people want to buy than sell. With the U.S. economy gradually recovering, corporate profits on the rise and Europe apparently stable (at least for the moment), investors are finally taking the bait that the Central Banks have been dangling in front of them for months. Equity markets are finally going up as a result.
Are stocks now overpriced? By most measures, valuations (based on Price/Earnings ratios) are still reasonable and in-line with history. The nay-sayers point to the fact that corporate profit margins are higher than average and predict that they will come down. Therefore they say P/Es are actually higher than warranted. Others look at the Shiller P/E ratio, which takes average earnings over the past ten years in order to smooth out history. In rebuttal, Wharton finance professor Jeremy Siegel points out that U.S. corporate margins are higher than historically because U.S. companies have more international business than ever before which traditionally is a higher margin business. Information Technology businesses also have higher margins than other sectors and now represent a bigger share of the U.S. economy. It has also been pointed out that looking back at ten years of earnings from 2003 to 2012, the Shiller ratio is actually now skewed, rather than smoothed. The last ten years include both the “tech-wreck” and the financial crisis of 2008/2009. These years are terrible outliers for corporate earnings and therefore do not present a ‘normalized’ historical average.
Regardless of the debates, any advisor should make sure that investors are always prepared for market downturns. While currently there may be no particular reason for one, the market doesn’t always need a reason. It is the sum of the actions of millions of emotionally motivated participants and volatility should be expected at any time. But of course, predicting when a correction will occur, and how much the market will go up before it corrects, is impossible. All we at Cardinal can do is make sure we only own companies that are fairly priced, that our companies have sustainable profit levels, and are likely to be providing high and/or growing dividends. If we can do that, our companies are worth their price, no matter what the market does.
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