Since it’s September and everyone is back to work or school, and I haven’t reviewed the Canadian market for a while, let’s have a look at our model price charts.
First, let’s have a look at the long-term model price chart of the S&P/TSX Composite Index to get some context of where we are and more importantly where we are going – probably.
Long-term Model Price Chart
S&P/TSX Composite Index with monthly price bars and EBV Lines (colored lines)
As you can observe the S&P/TSX Composite is in the zone between EBV+2 and EBV+3. It doesn’t take a brain surgeon to figure out that this index will probably reach EBV+3 over a period of time especially if the US market reaches EBV+4. Again timing is difficult for us but at least we have a roadmap.
And like my comments on the S&P 500, I believe the most likely scenario will be for this Canadian index to rise to EBV+3 (Red Line) and then crawl along EBV+3 when the S&P/TSX Index finally achieves this EBV level – see illustrated on model price chart above.
Zeroing in to our short-term model price chart reveals the following
S&P/TSX Composite Index with weekly price bars and EBV Lines (colored lines)
As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the Index itself), so we can see where the market – S&P/TSX Composite Index – is trading relative to its EBV lines.
As you can observe the Canadian market, as defined by the S&P/TSX Composite, is in the middle of the zone bookmarked by EBV+2 and EBV+3. If the market rallied to EBV+3 (19,592) this would represent a gain of some 26%. If the market corrected back to EBV+2 (14189) investors would be suffering losses of almost 9%.
For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.
So the question of the day is, “What industry sectors need to rally in order for the S&P/TSX Composite to rally up to EBV+3?”
When one looks at the S&P/TSX Composite Index three industry sectors make up 84% of the total Canadian composite index value. Financials make up a large 34.4%, with Energy 26.2% and Utilities/Telecoms 23.4% making up the balance (of the total 84%). So let’s do a quick review of each sector to get a sense what these three sectors need to do for the S&P/TSX Composite Index to achieve EBV+3.
Canadian financial stocks have been buoyant for much of 2014 as you can see from our long-term model price chart on the S&P/TSX Financial Sector.
S&P/TSX Financial Sector Index with monthly price bars and EBV Lines (colored lines)
But as you can observe from the above chart the overall sector valuation was substantially higher, over EBV+2, in 2007. Even in 1998 the Canadian financial sector peaked in valuation over EBV+1.
So a reasonable person can conclude that valuations in this sector could go higher, at least history does show higher past valuations.
Canadian energy stocks have had a good 2014, even though the sector has become stalled in the last month. This is logical because one can observe from the below S&P/TSX Energy Sector Model Price chart that the sector of energy companies has rallied just under EBV+3 and encountering resistance.
S&P/TSX Energy Sector Index with monthly price bars and EBV Lines (colored lines)
Looking at past valuations one can observe the positive transit of EBV+3 back in 2004, with the sector rallying to an eye popping EBV+5! One can also observe a positive transit of EBV+3 back in 1996 and rallying mid-way between EBV zones 4 and 5.
Clearly the Canadian energy sector does have room to rally and probably has to rally past EBV+3 to take the S&P/TSX Composite Index to EBV+3.
S&P/TSX Telecom Sector Index with monthly price bars and EBV Lines (colored lines)
Hmm…. No surprise here.
Looking at the S&P/TSX Telecom sector we are at valuation highs going back to 1995. Some may point to 1998 to 2000 to say this index was at EBV+5 and higher. I discount this because Nortel was part of BCE at the time – remember – skewing both the valuation of BCE and our EBV valuation.
The bottom line here is the telecom index won’t provide much help in the S&P/TSX Composite index reaching EBV+3
Now this was a surprise to me.
I thought ‘interest sensitives’ would be at the highest equity valuation since interest rates are currently at historic lows. But as you see on our S&P/TSX Utilities sector model price chart there is some headroom for the Utilities sector to reach EBV+3, as it did back in 2007.
S&P/TSX Utilities Sector Index with monthly price bars and EBV Lines (colored lines)
You can also see back in 1998 this sector almost reached EBV+3.
Can the S&P/TSX Composite Index reach EBV+3?
Sure, there seems to be headroom, for valuation increases based on past years valuation highs, in the sectors that make up 84% of the Composite index that I have illustrated.
Can the S&P/TSX Composite Index reach this important valuation level, EBV+3, without the help of U.S. equity markets? No, of course not. But as the most watched S&P 500 Index pushes up to EBV+4 the less globally watched Canadian composite index will probably get pulled higher as well. This makes sense and jives with financial history.
Am I saying this is a slam-dunk that equity markets, on both sides of the North American border, will trade substantially higher in the near future and without risk? Of course not! But viewing valuation through the prism of our model price charts not only at the composite level but also at the individual sector level can give an investor an invaluable insight and a roadmap on a probable future valuation levels that equity markets can achieve based on the past valuation highs (and lows).