Trade war holds back Canadian stocks in first half, but tide could be turning

Despite making little gains so far this year on trade tensions, market strategists are predicting that it won't be difficult for the Canadian stock market to bounce back and outperform in the second half of 2018.

Some strategists expect the Canadian stock market to rise more this year than it did in 2017

Gains in the energy sector drove Canadian equities higher in the second quarter. Some strategists expect that to continue in the second half of the year. (Darren Calabrese/Canadian Press)

Canada's stock market, like so many Canadian industries, was left shaken as traders grappled with the prospect of a full-blown trade war with the United States in the first half of 2018. 

Canadian equities started the year down, dragged lower by volatility that rocked U.S. markets in the first quarter. But they have roared back to life in the past three months.

Yet, despite the highs and lows of the past six months, the benchmark S&P/TSX composite index is trading around flat for the year and, when compared to its G7 peers, is sitting near the bottom of the pack.

In the second quarter, however, the Canadian market outperformed most major developed markets by rising more than six per cent overall. If that's any indication of things to come, strategists say Canadian equities could bounce back despite fears of a trade war.

Brian Belski, chief investment strategist at BMO Capital Markets, is betting on positive developments from NAFTA negotiations, pipeline approvals and a softening housing market to ultimately drive the TSX higher in 2018.

"We continue to believe the pessimism [in Canada] is misplaced and investors should expect another year of positive stock market performance, despite all the concerns about domestic growth, NAFTA, oil prices, and weak gold prices," Belski said in a note to investors.

"Ultimately, Canada's longer-term fortunes are likely to mirror the accelerating growth in the U.S."

The U.S. economy is expected to grow 2.8 per cent this year, according to U.S. Federal Reserve, which is 0.5 percentage points higher than its growth last year. In comparison, the Bank of Canada forecasts the Canadian economy will grow two per cent this year. It expanded by three per cent in 2017. 

Bigger gains than last year?

Belski forecasts that the TSX index will jump more than eight per cent in the second half of the year, hitting a target of 17,600 points. That prediction puts the index's gain for this year at more than eight per cent — higher than six per cent rise it saw in 2017.

Similarly, Ian de Verteuil, the head portfolio strategist at CIBC World Markets, is expecting a nearly five per cent gain on the TSX this year — even though trade disruptions remain a significant risk to his investment strategy.

Some strategists predict the Canadian stock market can still rise more than it did in 2017 in spite of current trade tensions between Canada and the United States. (Sean Kilpatrick/Canadian Press)

"White House threats on auto tariffs and a commitment to escalate if countries retaliate are concerning developments, but we still assume the [U.S.] administration is after 'more not less' trade," de Verteuil said in a note.

"Under all the rhetoric, there is some progress on autos and the China relationship, and even a renegotiated NAFTA is not too difficult to envisage. To be clear though, progress will not be in a straight line."

Meanwhile, Kurt Reiman, chief investment strategist at BlackRock Canada, said he didn't think matching last year's performance of a six per cent gain is a high hurdle for the TSX this year, especially if the momentum in the energy sector remains strong.

But not all strategists are convinced that Canadian stocks will be able to weather the storm being brought on by the Trump administration.

Sadiq Adatia, chief investment officer at Sun Life Global Investments, thinks the Canadian market will continue to trade  without making any significant gains in the second half of the year.

He predicts a target range of 16,000 to 16,250 points for the TSX in 2018. 

Problem with consumers

Given Canada's lacklustre performance in comparison to other developed countries, many people have realized that other markets may not carry the same risks this country is facing, Adatia said. He cited an overheated real estate market, high consumer debt and NAFTA.

"We also cannot forget that the Bank of Canada has also raised interest rates three times and going on to four, which should slow down consumer spending going forward," he said.

The Bank of Canada is widely expected to raise interest rates again next week after making three hikes since July of last year.

Adatia recommends pulling back from stocks that are tied to consumers. Consumers are likely not going to be able to contribute to the economy as they have in the past, he said.

Aggressive on energy

However, the strategists said that other sectors — such as energy and technology — should hold up well on the TSX for the rest of this year.

Belski is betting big on the energy sector, which was a key driver of Canadian equities in the second quarter. He's upgraded his overweight positioning on the sector.

"We believe Canada is poised to outperform the second half as oil prices reset a new trading range (still a tight range, but higher) and housing prices firm," he said in an interview.

De Verteuil of CIBC has also become more aggressive on the energy sector after pulling back from financials such as banks because of their exposure to consumer debt and the housing market.

Reiman, however, is taking a more cautious approach. He sees greater global economic uncertainty in the second half of the year and tighter financial conditions, such as higher interest rates.

"We recommend taking some risk out of equities, specifically our allocation to Japanese and European stocks where upside appears more limited, and investing the proceeds in short-duration fixed income [such as bonds]," Reiman said.


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