Outlook for our oil and gas holdings

Stock market outlook

In a Q1 letter to our clients, we wrote the following: “Year-to-date, both the S&P 500 and the TSX suffered 10% plus peak to trough declines. However, both the S&P 500 and the TSX hit all-time highs in January – at 2,873 for the former and 16,421 for the latter. In early February, both indices hit lows of 2,532 and 14,786 respectively. Technical analysts feel happier when stocks or indices retest lows but fail to break below them. That has been the case to date with both the S&P 500 and the TSX. The former bottomed again at 2,553 in early April while the TSX bottomed at 14,990 also in the first week of April. Technicians would be more encouraged by the fact that the S&P 500 – as at April 13 at 2,656 - is above its 200-day moving average of 2,615 while the TSX at its April 13 close of 15,273 is still below its 200-day moving average of 15,645.

In our April 1 Strategy Note, we provided our updated market outlook for 2018. In essence, in normal times, we take a historical multiple range for the appropriate investment criterion (EPS, CFPS and book value) and apply it to consensus forecasts for those three metrics for the TSX and to EPS alone for the S&P 500. However, assuming no large increase in risk aversion among investors, we think it fair to use the average for these metrics for the last three years. Applying these to Bloomberg consensus forecasts provides a target for the TSX of 16,630, which makes for a 9% capital gain and 12% total return from current levels. We would have a higher target of 18,000 for a total return of 20% if the 2018 year end oil price moved back to the $75 plus area a barrel, which we think is quite possible after the most recent rally in the WTI price.

In the case of the S&P 500, if we use a similar projected P/E of 17.3 times (the TSX’s last three year average) on blended forward 12-month EPS, we get a target of 2,785 for a capital gain of 5% from current levels and an 7% total return which is inferior to what would be the case for Canada’s index (+12%) using the same methodology (more so if oil prices rise to $75 a barrel). If these projections came to pass (although we have to rate the prospect as a possibility rather than a forecast at this stage), it would rival the performance of the TSX in 2016 when the Canadian index was the best performing equity market in the developed world. It is clear that Canadian equities are relatively very cheap chiefly caused by negative publicity on Canada’s inability to get its oil to tidewater, fears over NAFTA abrogation and  concern by international investors that the Canadian residential housing market would collapse like the U.S. housing market did a decade ago. We are confident that our housing market won’t replicate the U.S. experience – particularly after recent interviews with Canada’s big five banks although prices will correct - and clarity on the first two factors could be forthcoming in the next few weeks.”

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