Profits to Drive Canada's S&P/TSX to 14,500 Next Year, UBS Strategist Says

Canada’s benchmark equity index will rise 10 percent by the end of 2011 as corporate profits continue to increase and low yields make corporate bonds less attractive than stocks, UBS AG’s chief Canadian strategist said.

The Standard & Poor’s/TSX Composite Index will advance to 14,500 even if corporate earnings increase less than two-thirds as fast as analysts estimate on average in a Bloomberg survey, George Vasic said in a note.

“As we move further down in the year, the macro risks will become less cataclysmic,” Vasic said in an interview in Toronto. “There isn’t a better game in town. Of all the major asset classes, it’s tough to come up with something that has better medium-term potential” than stocks.

Canadian stocks are cheaper than they have been most years since 1988, according to Vasic, who uses a model that compares share prices with book value, return on equity and corporate bond yields. Investors using simpler valuation models, such as comparing share prices to profits alone, fail to realize the potential for further price gains, he said. The S&P/TSX trades for $17.76 per dollar of estimated profit over the next year, compared with an average of $15.06 since the beginning of 2006.

“There is more valuation headroom than most investors appreciate,” he said. In September 2009, when the S&P/TSX was near 11,500, Vasic forecast the index would rally to 13,500 by the end of 2010. The Canadian benchmark gained 12 percent this year, closing at 13,148.35 today, as commodity prices have surged on demand from emerging markets and easing concern that the economy will return to recession.

Dividend Boost

The index advanced 195.47 points, or 1.5 percent, to a two- year high of 13,148.35 today as banks gained after National Bank of Canada boosted its quarterly dividend.

Corporate profits are likely to climb again in 2011, despite historically high unemployment, as companies squeeze out more productivity gains, Vasic said. S&P/TSX profits rose 7.4 percent in the third quarter from a year earlier, according to Bloomberg data.

“The profit cycle is ahead of the economic cycle,” he said.

Unemployment isn’t as bleak as many assume, Vasic said. Employment in the U.S. rose in October for the first time in five months, a sign businesses may be starting to gain confidence in the prospects for a faster pace of growth. Seventy-five percent of Canadian exports went to the U.S. last year, according to Statistics Canada.

Looser Lending

U.S. employment should continue to increase in 2011, led by small and medium-sized businesses, as regional banks loosen their lending policies, he said.

China’s efforts to restrain inflation and the European debt crisis, which have limited equity gains this year, are unlikely to derail advances in 2011, Vasic said. China is likely nearing the end of its tightening phase, and progress toward coordinating tax and spending policies should help Europe recover.

With Canadian corporate bond yields below 4 percent and the Bank of Canada likely to double its benchmark interest rate to 2 percent by the end of next year, investors will have to turn to equities if they want a reasonable return on their investment, Vasic said.

“Bond investors at this point would be lucky to get their coupon,” he said.

Materials, Banks

Of the three industries that make up 76 percent of Canadian stocks by market value -- financial, raw-material and energy companies -- Vasic said financials are most likely to outperform the rest of the market in 2011. Banks, which have climbed 8.9 percent in 2010, should continue to benefit from historically low interest rates.

Energy stocks may trail the broader market as crude oil, held back by excess capacity, trades between $70 and $90 a barrel in New York. The fuel closed at $84.11 a barrel yesterday.

Vasic’s valuation method shows European stocks, especially those in the U.K., have even more room to gain next year than do Canadian equities. The Stoxx Europe 600 index has lagged behind the S&P/TSX and S&P 500 this year, gaining 5.2 percent, as sovereign-debt concerns have held back equities there as well as bonds.

“If we go back to a situation where the world appears to be stabilizing, well I’m sorry, but quality doesn’t do as well as garbage,” he said.

To contact the reporter on this story: Matt Walcoff in Toronto at mwalcoff1@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.