Tuesday, September 15, 2009

TSX hits my target! Now what?

All the way back in May I made the bold prognostication (read: wild guess) that the TSX should be valued at between 11,400 and 11,500 - up from about 10,200 at the time. I hazarded a guess that the TSX might get to that level by the end of 2009, however it decided not to wait until the end of the year, closing at 11,496 today.

In my previous post I suggested that the market was undervalued and would be pricing in 2009 TSX earnings of about $575 per share. I then applied a long-run average PE multiple of about 20 to arrive at my call of 11,400-11,500.

Current estimates for 2010 corporate profits are in a range of 5-10% growth. My own model of corporate profits is spitting out growth of 30% (which I don't quite believe) - so lets say TSX EPS of around $630-$750. Since so much depends on the multiple applied to these profits, i've made a quick and dirty attempt at incorporating a PE equation based on short and long-term interest rates and nominal GDP growth into my Canadian economy model. The model derived PE suggests an average multiple of between 17-18 over the next year. Applying this multiple to the above range of forward earnings gives a fair value for the TSX of between 11,400 and 13,500, suggesting a market going sideways or a market about to pop by about 20%. A big range to be sure, but perhaps that is consistent with the amount of uncertainty in stock prices.

Could I have arrived at this range by pulling numbers randomly out of a hat? Probably, but what fun would that be?

Monday, September 7, 2009

The Training Wheels Economy

Looking at the most recent National Accounts data from Statistics Canada provides a sense that the Canadian economy can’t quite stay upright on its own. Luckily, the Government and the Bank of Canada have committed to stabilizing the economy until it can, sort of like a set of training wheels on a bike.

For its part, the Bank of Canada has committed to keeping its target rate at an effective lower bound of 25bps until the second quarter of 2010. The fiscal stimulus proposed by the Federal Government is projected by the Bank of Canada to contribute about 2.3% to GDP over the next year and a half, including close to half of the Bank’s projected growth for 2010.

So how long might the economy need training wheels? Well, personal consumption and residential investment seem to have turned, which is normally the case at the end of a recession. However, if this recession is anything like the past, private sector investment in non-residential structures and machinery and equipment may not recover for a while, particularly if bank lending remains tight.

Non-residential investment in structures and M&E contributed an average of about 1% to annual real GDP growth from 2003-2007 before subtracting growth in 2008 and 2009. The fiscal stimulus should go a long way in replacing that growth in 2010, but if consumption growth stalls or the loonie creates a larger than expected drag on exports, we could be looking at keeping the training wheels on for an extended period. If not, a 1980-1982 style double-dip recession is a real possibility.