With little room for earnings growth and well-priced valuations, there’s likely not a lot of upside to the Toronto Stock Exchange in 2013, says UBS Securities Canada Inc.
In a new report, the firm suggests that it sees little room for equity gains in the year ahead. “The overall picture for the TSX adds up to one of limited upside through a combination of near normal valuations and only modest scope for earnings expansion,” it says.
“Specifically, though the forward P/E of 12.4x still looks low relative to the 14.5x historic norm, margins and ROEs at near peak levels offer little upside,” it adds. And, the trailing P/E ratio is close to historical norms at 14.1x.
As for the earnings picture, the report says that, “After a significant rebound following the global financial crisis, earnings are entering a new, and slower phase, of the cycle.” It predicts that earnings growth will be limited by revenue growth, “which in turn will broadly track nominal GDP, which looks to be in the 4%-5% range.”
As a result, the firm now has a 12-month target for the S&P/TSX Composite index of 13,000, down from 14,000; which, it says, represents a 14x multiple on its earnings estimates, and 13x what it expects the forward estimates will be in a years time.
The report says that investors should “retain a defensive tilt” over the cycle; and, that “investors need to counterpunch periods of strength and weakness in markets within the cycle.”
In general, UBS says it prefers sectors with earnings certainty. “Our most preferred are the seven consumer/industrial etc. sectors that are roughly one-quarter of the TSX, as their earnings revisions have been minimal and their long-term growth is in the high single digits,” it says. “Next are the financials, who have earnings certainty but lower growth, followed by energy and materials which have the highest expectations and suffer the brunt of the revisions.”
Downside macro risks to the outlook include growth disappointments in China undermining commodity prices, as well Eurozone (Spain and Greece), and US fiscal cliff and debt ceiling challenges, it says. Also, operational issues in the resource sector could lead to larger than usual cuts to earnings estimates, it cautions.
Conversely, US growth could surprise to the upside, it notes. “Within equities, while valuations are constrained there is room for re-rating, and could produce material upside if operational execution is also strong and so earnings estimates come to pass,” it says.