"If Santa Claus should fail to call, bears may come to Broad & Wall."

Analysts see equities under pressure until the U.S. musters an economic recovery – perhaps in the back half of 2009

January 01, 2009

RITA TRICHUR
BUSINESS REPORTER

"If Santa Claus should fail to call, bears may come to Broad & Wall."

That adage – coined by Yale Hirsch, founder of the Stock Trader's Almanac – warns that if the traditional Santa Claus rally fails to materialize during the last five trading days of the outgoing year and the first two of the new one, it is a bad omen for stocks.

The last five trading sessions of 2008 produced a flurry of mixed results for key New York indexes, while the Toronto stock market mostly posted gains. It remains to be seen how investors will ring in the new year when trading resumes tomorrow. Nonetheless, analysts suggest that glad tidings may be in short supply in 2009 – at least for the near term.

Since mid year, stocks on both sides of the border have been trapped in a vicious bear market that has already proven to be one of the worst ever for Toronto's main stock index.

Despite soaring to a record-breaking high of 15,073.13 on June 18, Toronto's S&P/TSX composite index posted a 35 per cent loss for 2008 as the crisis of confidence that infected credit markets also proved contagious for stocks.

If past experience is any guide, the average TSX bear market requires about three years to return to its previous peak.

The bad news, experts say, is that markets will likely remain choppy in the short term.

"We anticipate that Canadian equities will remain under pressure through 2009; our end-2009 TSX composite target is 8,000, and we expect the market to trade somewhat lower than that through the year," said David Wolf, an economist with Merrill Lynch, in a recent report.

"Our TSX operating EPS forecast for 2009 is $620, down 35 per cent from 2008 and 28 per cent below the bottom-up consensus. We cannot call a bottom for equities until Canadian market participants evince a more realistic and balanced assessment of the drastically changed macro environment and until greater visibility allows risk premiums to ebb."

Underpinning his "still-bearish outlook" is a two-pronged argument that contends analysts' revised earnings forecasts are still too upbeat, while stocks are "not nearly as cheap" as they might seem.

"Based on the bottom-up consensus EPS (earnings per share) number for 2009, the TSX is currently trading at 10 times forward earnings, indeed close to the lowest levels we've seen in 20 years," observed Wolf. "But using our $620 forecast, the market is trading at more than 13 times forward earnings, no cheaper by this metric than has generally been the case over the past several years."

Wolf may be known for his bearish views, but even traditional equities bulls are advising investors to tread cautiously. Among them is Paul Taylor, chief investment officer for BMO Harris Private Banking, who warns the first half of 2009 will be "very challenging" for capital markets.

"As a result we plan to only be a very selective buyer of Canadian equities early in the year," stated Taylor. "However, as economic growth re-ignites, there will be an opportunity for a rotation into more cyclical stocks and sectors."

Even allowing for that smidge of optimism, Taylor's cautious stance is a marked shift from last April when he predicted the outlook for equities would improve during the second half of 2008.

Taylor, however, is not the only Bay Street veteran altering forecasts in the face of deepening economic woes. Jeff Rubin, chief economist of CIBC World Markets, recently pared his 2009 year-end TSX target by 1,000 points to 11,000. In doing so, he counselled clients to "think twice before bulking up on stocks just yet."

Last June, Rubin predicted that strong crude oil prices would spur the TSX to hit a record high of 15,200 by the end of 2008. It didn't quite make it, but came within spitting distance as commodity prices soared.

As oil prices reversed course, however, he slashed his short-term target to 9,500 and then again to 9,000 on Dec. 10. The TSX actually ended 2008 at 8,987.70 points.

"We continue to expect the North American economy to contract over the first half of the year, with near-term punitive consequences for earnings," Rubin said, suggesting that investors "going long stocks now should be prepared for more jolts along the way."

Despite the darkening economic outlook, Rubin does hold out hope that "more than reasonable" returns could be generated over the next 12 months. His prediction largely hinges on plans for a mammoth fiscal stimulus from the American government. Such measures, he said, "should resuscitate growth by the second half of the year, spelling a recovery in both earnings and commodity prices, particularly energy."

Vincent Delisle, director of portfolio strategy at Scotia Capital, also suggests the long-term equity outlook is poised to improve even if the not-so-distant future looks dim.

"Since Canada's economy and equity market lag the U.S. by approximately 12 to 18 months, 2009 will be the year where Canada's numbers visibly deteriorate," Delisle said. "Our 2009 TSX EPS forecast is set at $650, pointing to a 32 per cent decline in TSX earnings."

Delisle suggests that S&P 500 earnings will likely rebound before those of the TSX. With that being his "index of choice," his "defensive" sector preferences include financials, discretionary, consumer staples and utilities.

He agrees it may be too soon to call a definitive bottom, but observes that past bear markets have either rebounded or fell into a trough during recessions rather than times of economic recovery. Historical data suggest S&P 500 bear markets typically end about eight months before the job market heals.

CIBC economists Peter Buchanan and Meny Grauman, meanwhile, suggest the TSX's bottom could be nigh if the United States manages to muster an economic recovery during the back half of 2009.

"The good news is that since the 1920s Canadian stocks have tended to bottom between three and nine months before the end of a U.S. recession, with the median being around five months," they wrote.

"True, the economic challenges facing the country are nearly unprecedented, but so too is the accompanying government response."