Oct. 12 (Bloomberg) -- Canada’s main stock index may rise 9.5 percent within six months, National Bank of Canada said, citing a gap between stock and bond yields that suggests investors overreacted to the risk of a U.S. recession.
The gap between the earnings yield of Standard & Poor’s/TSX Composite Index stocks and the yield of Canadian corporate bonds has widened to levels seen only once since 1988, during the 2007-09 U.S. recession, said Marco Lettieri, an economist at the Montreal-based lender. Since the U.S. economy is still growing, the yield gap should be half the size, which would require stock prices to rally.
“The common shareholder is probably the most-exposed to the financial risks in the market,” Lettieri, who wrote a note to clients on the topic last week, said in a telephone interview yesterday. “There’s probably a desire to reduce risk from people’s portfolios, and that means you would reduce your position in equity markets. However, if a recession is averted, these valuations do give investors an attractive entry point.”
The S&P/TSX sank 17 percent from April 5 through yesterday as global equity markets plunged on concern that the European debt crisis will send the world economy back into recession. Canada’s benchmark stock index fell to the lowest relative to earnings since July 2009 on Oct. 4.
The gap between the S&P/TSX’s earnings yield, or earnings divided by price, and the yield of the Bank of America Merrill Lynch Canadian Corporate Index of bonds climbed to 3.56 percentage points last week, the widest since March 2009, according to Bloomberg data. The historically low bond yields eliminate an alternative to investing in stocks, Lettieri said.
If the U.S. avoids a recession, the S&P/TSX probably would rise to 13,000 in three to six months, he said. The index gained 2.5 percent to 11,875.55 yesterday.
National Bank, Canada’s sixth-largest lender, forecasts a 35 percent to 40 percent chance of a U.S. contraction over the next 12 months. Efforts by European politicians to reduce uncertainty by addressing their debt and banking crises are the best bet to head off a global recession that would drag the U.S. down with it, Lettieri said.
The U.S. economy is the most-important factor for the S&P/TSX because of Canada’s dependence on exports to the U.S. and the weighting of resources companies in the index, he said. The U.S. accounted for 75 percent of Canada’s exports last year, according to Statistics Canada. Energy and raw-materials companies make up 47 percent of the country’s stocks by market value, according to Bloomberg data.
--Editors: Stephen Kleege, Joanna Ossinger
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