Canada's main stock index will notch a record high by year-end as higher commodity prices and rising interest rates boost cyclical stocks, a Reuters poll found, offsetting investor worries about domestic economic imbalances. Cyclical sectors financials, energy and materials account for about 65 percent of the weight of Canada's stock market. They tend to perform better late in the economic cycle as robust global growth boosts demand for commodities and central banks fight inflation by raising interest rates.
"We are moving into the mid-to-late part of this cycle, which is a time when commodity prices and resource stocks have done particularly well, a positive sign for Canada," said Colin Cieszynski, chief market strategist at SIA Wealth Management. "Rising interest rates are a sign of a strong North American economy which can put a tailwind behind stocks."
The energy group on the Toronto Stock Exchange has climbed more than 20 percent since February, boosted by a 3-1/2-year high for crude oil prices. The rally in energy shares has helped lift the TSX to near unchanged for the year after posting in the first quarter its weakest performance since 2015.
Investors expect the recovery to continue and for the S&P/TSX composite index to eclipse January's record high of 16,421.42. The median forecast from the May 15-30 poll of 28 portfolio managers and strategists was for the Toronto market to rise 5.7 percent from Tuesday's close to 16,825 by the end of 2018. It is then expected to climb further to 17,500 by the end of 2019.
Investor enthusiasm for Canada's stock market has been dampened by an uncertain outlook for trade, including renegotiation of the North American Free Trade Agreement. The collapse of NAFTA could hurt shares of auto parts, railroad and energy companies, that depend on trade with the United States. Still, prospects for the completion of a major oil pipeline expansion have been bolstered. The Canadian government said on Tuesday it will buy Kinder Morgan Canada Ltd's Trans Mountain pipeline for C$4.5 billion, hoping to save a project that faces formidable political and environmental opposition.
"Canadian equities have been unfairly punished" as investors worry about a number of uncertainties, said Candice Bangsund, portfolio manager, global asset allocation at Fiera Capital Corporation. Bangsund expects Canadian stocks to play catch-up with more expensive valuations on Wall Street as investors rotate out of sectors such as technology, in which Canada is lightly represented, to cyclical stocks.
As prospects for domestic economic growth have improved, the Bank of Canada has been hiking interest rates, which can help reduce the value of insurance companies' liabilities and raise margins for banks. "The economic backdrop still looks constructive, central banks are moving at a measured pace," said Mike Archibald, associate portfolio manager at AGF Investments.
But investors also worry increased interest rates and domestic economic imbalances, such as high consumer debt, tighter mortgage regulations and a softening housing market will over time slow growth. Higher interest rates could also reduce the amount investors are willing to pay for each dollar of a company's earnings.