The S&P/TSX Composite Index has been on a tear, rising more than 6 per cent over the past eight consecutive trading days.
This may only be the start to a fantastic February for equity investors. Here are 10 reasons why the positive momentum in the stock market may continue.
The trend is your friend
Despite recent market volatility, the bull market remains intact.
On Feb. 10, the S&P/TSX Composite closed at a record high. Breadth is good with stocks from different sectors participating in the rally; more than 60 per cent of the stocks in the S&P/TSX have seen their share prices rise year-to-date. Small cap stocks are also sharply higher with the S&P/TSX Small Cap Total Return Index up 11 per cent year-to-date.
Seasonal strength
Looking back to 2005, the S&P/TSX Composite has delivered positive returns in February 75 per cent of the time, the exceptions being in 2020, 2018, 2009 and 2006. However, last year, the S&P/TSX was up 3 per cent until Feb. 20 when news about COVID-19 sent stocks spiralling down.
In 2009, all losses experienced in February were recovered just one month later. In 2006, all losses were erased within the first three trading days of March.
This seasonal strength has historically extended into the second quarter.
Supportive fundamentals
In a report issued on Feb. 4 by Refinitiv, 77 per cent of the companies that have reported their fourth-quarter earnings results have exceeded the Street’s expectations.
Rising growth expectations are also a positive. Earnings for the first half of 2021 are expected to soar, anticipated to expand by 42 per cent year-over-year in the first quarter and by 74 per cent year-over-year in the second quarter.
These forecasts are slightly higher than at the start of the year.
On Dec. 31, Refinitiv reported year-over-year growth expectations of 41 per cent in the first quarter and 71 per cent in the second quarter. The upward earnings revisions are being driven by the energy sector, with the price of West Texas Intermediate (WTI) crude oil nearing the US$60 a barrel level, up from about US$48 at the end of 2020.
High valuation, but not outside the norm
According to Refinitiv, the S&P/TSX Composite is trading at 13 times 2021 earnings, the upper end of its historical range. Elevated multiples may be maintained given equities offer investors the potential to make attractive returns that may not be available in other asset classes, namely fixed income securities.
In addition, earnings estimates may be too conservative, making the current forward price-to-earnings ratio artificially low. Business and consumer activity may rebound sharply as the vaccine rollout progresses.
With respect to individual stocks, many analysts wait until a company has reported its fiscal year-end results (typically coinciding with the calendar year). Consequently, some analysts will be introducing their 2022 earnings estimates and rolling forward their valuations based on anticipated 2022 earnings in the coming weeks.
Low interest rates
This provides a favourable backdrop for stocks. It provides businesses with access to cheap capital in order to fund capital expenditures and management’s growth objectives. In addition, individuals are able to borrow money at very attractive rates and consumer spending is a key factor to an economic recovery.
Steepening yield curve
We are seeing a widening in yields between shorter-term and longer-term government bonds. Generally, this signals expectations of improving economic conditions and is positive for the overall stock market.
Investor sentiment
For the week ended Feb. 3, the AAII Investor Sentiment report, which measures investors’ expectations for the market over the next six months, showed a large dip in the bullish camp with 37 per cent of investors bullish, down from 45 per cent reported three weeks ago; 27 per cent of investors were neutral, up 4 per cent; and 36 per cent of investors were bearish, up from 32 per cent. (AAII stands for the American Association of Individual Investors.)
This is a contrarian indicator.
When there’s a large percentage of bulls and more people are optimistic, it typically marks a near-term peak for the stock market.
Income source
The S&P/TSX Composite offers an attractive yield of about 3 per cent. To put this in perspective, the Government of Canada 10-year bond yield is roughly 1 per cent.
Portfolio repositioning
Some institutional portfolio managers may take a more active and potentially aggressive portfolio management approach in the first half of the year, ahead of the summer doldrums and volatility in the fall in order to lock in high returns for the year.
In the second half of the year, they may take a more conservative approach, more closely aligning their portfolios with their respective benchmarks.
Millennial investors
Don’t underestimate the power of millennial investors. They often take a different approach – sometimes investing in stocks irrespective of their high valuations.
The greatest risk to stock markets is the COVID-19 pandemic, especially variants that are spreading globally, posing a threat to an economic recovery. However, for now, the vaccine rollout is advancing and macroeconomic conditions are constructive for stocks.
Furthermore, there is plenty of money sitting on the sidelines in money market assets that can be deployed. That may very well continue to drive stock prices higher.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.