Investment Strategy

Ryan Lewenza, CFA, CMT, Private Client Strategist

January 5, 2015

2015 Market Outlook

Table of Contents
Economic Outlook2-3
Fundamental Outlook4
Technical Considerations.5
Risks to Outlook.6
Positioning.7

Highlights

We see the North American (NA) and global economy gradually improving in 2015, with the US economy leading the way.
The US economy is forecasted to grow at 3% in 2015, up from 2.3% in 2014.

The Canadian economy stands to benefit from an accelerating US economy. We see the potential for higher exports on the
back of a stronger US economy and a weaker Canadian dollar. However, the Canadian economy should trail the US given
weak commodity prices and high consumer debt.

Our 2015 S&P/TSX Composite Index (S&P/TSX) price target is 15,300, which is based on a 17x P/E multiple and our
$900/share earnings forecast. Adding in a 2.8% dividend yield, we see the potential for a total return of 7.5%. We expect
the S&P 500 Index (S&P 500) to outperform the S&P/TSX for the fifth consecutive year.

While we see further upside next year it will likely come with higher volatility as the US Federal Reserve (Fed) normalizes
monetary policy by hiking interest rates in mid-2015. We see a decent first half followed by potential weakness in H2/15 as
the Fed begins to hike rates.

The technicals remain bullish and supportive of our fundamental call for additional upside. Key positive technical trends
include: 1) the S&P 500 remains in a long-term uptrend and is above its rising 40-week moving average (MA); 2) market
breadth remains supportive; and 3) numerous market cycles point to additional gains.

Key risks to our outlook include: 1) growth deceleration from key regions such as Europe, Japan and China; 2) a stronger US
dollar and its impact on the emerging markets; 3) significantly lower oil prices; and 4) the age of the current expansion
cycle.

Preferred Canadian sectors include: Financials, Consumer Discretionary, Industrials and Information Technology.
Underweight sectors include: Materials, Utilities and Health Care.

Please read domestic and foreign disclosure/risk information beginning on page 8

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

2015 Market Outlook

January 5, 2015 | Page 2 of 8

Economic Outlook
Our investment strategy framework begins with our expectations for economic
growth. We see the North American and global economy gradually improving in
2015, with the US economy leading the way. The US economy, which represents 22%
of global GDP, is forecasted to grow at 3% in 2015, up from 2.3% in 2014. Our US
economist is forecasting a more modest 2.75% next year (mid-point of 2.5% to 3%
forecast range), but nonetheless, we see the US economy improving, helping to drive
stronger global growth. Key supports for a stronger US economy include:

US labour market conditions continue to improve with the US economy

adding on average 240,000 jobs per month in 2014, up from the 194,000
average monthly job gains in 2013. In fact, last years job gains were the
strongest since 1999. As a result of the strong monthly gains (and a decline
in the participation rate) the US unemployment rate has declined from 10%
at the peak of the crisis to 5.8% currently. We see continued healthy job
gains driving the unemployment rate below 5.5% by year-end 2015.

The Composite PMI Is Consistent

With US GDP Growth Of 3%

The manufacturing sector continues to deliver solid gains, with the ISM
Manufacturing Index sitting at 58.7, well above the key 50 level. New orders
are incredibly robust at present, which bodes well for future production.

We see continued progress in the US housing sector driven by a stronger

labour market, improved consumer balance sheets and low interest rates.

While we expect capital spending in the energy sector to take a hit in 2015,
this should be offset by an increase in capital spending in other areas. With
US companies flush with cash and the average age of plant and equipment
at 22 years the oldest since the 1950s we see overall capital spending
ramping up next year, offsetting weakness from the energy sector.

60

55

The composite PMI index, which includes ISM Manufacturing and Services,
currently sits at 59.1 and is consistent with US GDP growth of 3% (sidebar).

65

50
0
45
-2

40

-4

ISM Composite (LHS)

35

US GDP Y/Y (RHS)

30

-6
'00

'02

'05

'08

'11

Source: Bloomberg

Finally, lower oil prices are likely to have a positive impact on economic
growth next year. Consumer spending accounts for roughly 70% of US GDP
while oil and gas capital spending represents 1% of GDP. Given this calculus,
lower energy prices should provide a net benefit to the US economy.

Putting it all together we see the US economy delivering stronger economic growth
next year, helping to push global growth higher in 2015.
US Job Gains Highest Since 1999

US GDP Growth To Increase To 2.75% In 2015

500

11

300

10

100

-100

-300

1.0

-500

0.0

6.0
4.6

5.0

US Nonfarm Payrolls Mthly Chg (LHS)

2.9

3.0

4
'07

'08

'09

'10

Source: Bloomberg, Raymond James Ltd.

'11

'12

'13

'14

2.7

2.5

2.3

RJ Forecast

2.2

1.8

1.6

2.7 2.7 2.6 2.6

0.8
0.1

-1.0

US Unemployment Rate % (RHS)

-900

3.9

3.5

2.0

-700

4.6

4.5

4.0

-2.0
-3.0

-1.5

US GDP Growth Q/Q Annualized

-2.1

Q1/11 Q3/11 Q1/12 Q3/12 Q1/13 Q3/13 Q1/14 Q3/14 Q1/15F Q3/15F

'13

2015 Market Outlook

January 5, 2015 | Page 3 of 8

Canadian Outlook
With the important economic and financial linkages to the US economy, where it
goes, so does the Canadian economy. This is captured in the high (0.90) correlation
between the two economies. Given this relationship, the Canadian economy stands
to benefit from an accelerating US economy. In particular, we see the potential for
higher exports next year, on the back of a stronger US economy and a weaker
Canadian dollar. We expect energy-related exports to come under pressure next
year, but see other areas, such as machinery and autos offsetting the weakness in
energy. Exports rose 6.8% annualized in Q3/14, following a 17.8% increase in Q2/14.
We see this trend continuing in 2015, helping to propel the Canadian economy
higher. While we see stronger activity for the Canadian economy, we believe it will
continue to trail the US given two significant headwinds:

Canadians have taken on a significant amount of debt in recent years, as a

result of low interest rates and rising home values. Household debt relative
to disposable income has increased from 120% in 2004 to 165% today.
Putting this into context, US debt to income peaked at 163% prior to the
credit crisis and stands at 135% today. We expect Canadians to tighten
their belts as they look to address their high debt loads. If correct, this
could weigh on consumer spending and economic growth.

Heavily Indebted Canadians

Provides A Headwind To Growth
180
160
140
120

The second major headwind for Canadian growth is the weak outlook for
commodities. With the emerging markets slowing, this is resulting in lower
demand for commodities. For example, oil has declined precipitously from
US$105/bbl last summer to US$56/bbl today. While we expect oil prices to
firm up in H2/15, as global growth picks up, we still see oil trading in a new
lower range which should negatively weigh on the energy sector and
Canadian corporate profits.

100
80
Canadian Household Debt to Disposoable Income (%)

60
'90

'93

'96

'99

'02

'05

'08

'11

Source: Bloomberg

In sum, we believe the Canadian economy will benefit from stronger US growth;
however, key headwinds such as high debt loads and weaker commodities will result
in slower growth from Canada. We see economic growth closer to 2.5% versus 2.75%
for the US in 2015.
Canadian Economy Should Benefit From US Growth

With Exports Getting A Boost

r = .90

20%

15%

10%
5%

0%
-5%

-10%

-2

-15%
Canada GDP Y/Y

-4

-20%

US GDP Y/Y
'98

'00

'02

Canadian Domestic Exports Y/Y

-25%

-6
'04

'06

Source: Bloomberg, Raymond James Ltd.

'08

'10

'12

'14

'98

'00

'02

'04

'06

'08

'10

'12

'14

'14

2015 Market Outlook

January 5, 2015 | Page 4 of 8

Fundamental Outlook
Incorporating our GDP growth expectations into our earnings model we come up
with an S&P/TSX earnings estimate of $900/share which equates to growth of 6%
Y/Y. Our earnings forecast is 5% below the current bottom up consensus estimate of
$950/share, as we see the potential for further negative earnings revisions from the
resource sectors. This also helps explain why the earnings trajectories for the
S&P/TSX and S&P 500 have diverged in recent quarters, with S&P 500 earnings
continuing to power higher, while S&P/TSX earnings have weakened. Our more
constructive outlook for US earnings is one factor in our call for the S&P 500 to
outperform the S&P/TSX once again in 2015.
With the large equity gains since the financial crisis, valuations have expanded
markedly with the S&P/TSX currently trading at 18.4x trailing earnings and 1.8x price
to book value (P/B). For perspective, at the March 2009 low, the S&P/TSX traded at
10x earnings and 1.2x P/B. Clearly stocks are no longer cheap but nor are they
extremely expensive, in our view. While history suggests the potential for further
multiple expansion, this is not our base case for next year. We see upside next year
being driven by corporate earnings growth. Our official S&P/TSX price target is
15,300, which is based on a 17x P/E multiple and our $900/share earnings forecast.
Adding in a current 2.8% dividend yield, we see the potential for a total return of
7.5% in 2015 from current levels.
While we see further upside next year it will likely come with higher volatility as the
Fed normalizes monetary policy by hiking interest rates in mid-2015. Typically,
equities decline in the first few months after the first interest rate hike, but then
rebound on average 5%, 12 months following the first Fed hike. This is largely due to
the fact that the economy is doing better, which translates into stronger corporate
earnings. It is generally not until the third or fourth rate hike that the stock market
tends to peak, as investors fully realize that the Fed is intent on slowing down the
economy and tackling inflation. Therefore, we see a decent first half followed by
potential weakness in H2/15 as the Fed begins to hike rates. The expected first rate
hike is in mid-2015 which would coincide with the typically weak summer months.
Stocks could come under pressure in the summer/fall period, but by end of year, we
believe NA equities will be higher, in line roughly with corporate earnings growth.

$900

$100

$700

$80

$600

$60
$40

$400

0.0%

$0

$0
'98

'00

'02

'04

Source: Bloomberg, Raymond James Ltd.

'06

'08

'10

'12

-2.0%
-4.0%

$100

S&P/TSX Trailing Earnings (RHS)

'14

Equities initially decline

than gain 5% on average

4.0%
2.0%

$200

S&P 500 Trailing Earnings (LHS)

6.0%

$500

$300

'96

Source: Bloomberg. As of December 22, 2014

8.0%

$800

'94

S&P/TSX
S&P 500
Current Vs LT Av'g Current Vs LT Av'g
18.4
-3.2%
18.3
11.1%
15.6
0.0%
17.2
4.2%
1.9
-6.0%
2.8
-2.2%
5.4
-3.2%
5.5
-8.4%
2.9
45.2%
1.9
-20.5%

Equities Initially Decline Following Fed Hike Then Rally

$120

$20

Metric
Trail P/E
Fwd P/E
P/B
Earnings Yield
Dividend Yield

-6.0%

S&P 500 Average Performance After First Fed Hike

(periods include '80, '83, '88, '94 '99, '04)

1
12
23
34
45
56
67
78
89
100
111
122
133
144
155
166
177
188
199
210
221
232
243
254

S&P 500 And S&P/TSX Trailing Earnings

North American Equity Valuations Are

Above Average But Not At Extremes

Days

2015 Market Outlook

January 5, 2015 | Page 5 of 8

Technical Considerations
Our strategic framework incorporates both fundamentals and our technical readings
of the markets. When the technicals confirm our fundamental conclusions it
increases our confidence in our forecasts and helps provide a more complete
picture. Currently, the technicals remain bullish and supportive of our fundamental
call for additional upside in 2015. Key positive technical trends include:

The S&P 500 remains in a long-term uptrend and is trading above its rising
40-week MA, which we use to define the long-term uptrend. On a shortterm basis the S&P 500 is trading at resistance which could leave it
vulnerable to a pullback early in the year, similar to 2014.
The S&P/TSX is also in a long-term uptrend; however, it is currently below
its 40-week MA. Additionally, the S&P/TSX remains in a relative downtrend
versus the S&P 500, which is one factor in our call for the S&P 500 to
outperform the S&P/TSX in 2015 for the fifth consecutive year (sidebar).

The S&P 500 Has Outperformed

The S&P/TSX Since 2011
0.21
0.19

S&P/TSX
outperforming

0.17

Market breadth remains decent with the NYSE Advance/Decline (A/D) line
consistently making new highs. Often at major market tops the NYSE A/D
diverges with price action, providing an early warning signal. This is
currently not present.

0.15

A number of market cycles that we track are bullish for 2015. They include:

0.07

S&P 500
outperforming

0.13
0.11

0.09
S&P 500 Relative to the S&P/TSX

The Presidential Cycle, which posits that stock returns track the US
Presidents term, with years 3 being the best for stock returns.
Since 1945, the S&P 500 has returned an average 16% in year 3 of
the Presidents term, versus 6% for all other years.

US midterm elections have been very positive for subsequent S&P

500 12-month returns. Since 1945, the S&P 500 has posted a
positive return in every subsequent 12-month period following a
mid-term election, with an average price return of 17.5%.

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

Source: Bloomberg

The Decennial Cycle states that equities tend to trade in a 10-year

market cycle, with years ending in 5, 8 and 9 being bullish for stock
returns. Year 5 in particular has been the strongest. Since 1833,
there have been 18 years ending in 5, with 15 (83%) of those years
posting a positive return for the Dow Jones Industrial Average.
Both technicals and market cycles point to additional upside for the NA equity
markets in 2015, supporting our call for single-digit returns next year.
S&P 500 Remains In A Long-Term Uptrend

Presidential Cycle Points To Strong Returns In 2015

2,100

40%

1,900

35%

1,700

30%

1,500

25%

1,300

20%

Year 1

Year 2

Year 3

Year 4

We're here

15%

1,100

10%

900

5%

S&P 500
40-Week MA

700

0%

500
'05

'06

'07

'08

'09

Source: Bloomberg, Raymond James Ltd.

'10

'11

'12

'13

'14

-5%

S&P 500 Performance Over the FourYear Presidential Cycle (1945-2012)

Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Oct

'14

2015 Market Outlook

January 5, 2015 | Page 6 of 8

Risks to Outlook
Lets be clear, its not all roses. There are a number of headwinds that should they
intensify could put the global economy at risk. We believe on balance that the
positives outweigh the negatives, but they require close monitoring. They include:

Key regions such as Europe, Japan and China have weakened with their
growth decelerating or going negative in recent quarters. We see these key
areas stabilizing and posting stronger economic growth in 2015 due in part
to the lagged impact of monetary stimulus. However, should these areas
decelerate further, possibly due to an exogenous shock, this could impact
the global economy. Some believe the US economy could decouple from
weakness abroad, however, we are not in this camp. Continued weakness
abroad could put the US economy at risk.

We remain US dollar bulls on the back of tighter monetary policy from the
Fed. Historically, a stronger US dollar has been a headwind for the emerging
markets (EM) as it impacts trade, capital flows and monetary policy. As we
saw in 2013 when emerging market currencies and equity markets declined
on US dollar strength, should this occur again in 2015, it could be
destabilizing to the global economy.

Low oil prices are good, until they are not. We believe the weakness in oil
prices has been mainly supply-driven rather than demand-driven. As such,
weak oil prices are not signalling a global slowdown or looming recession, in
our view. We see oil prices firming up in H2/15 as global growth improves.
However, if this does not play out, and oil prices continue to weaken, they
could signal that something is amiss with the global economy.

Finally, the current expansion phase is getting older with the US economy
nd
entering its 22 quarter of expansion, which is in line with the long-term
average expansion cycle. We believe this cycle will last longer than normal
given the depth of the last recession and the unprecedented liquidity
injected into the financial markets. But the fact remains that this expansion
cycle is getting older and therefore requires close monitoring.

As always in the case of forecasting and investing, there are a number of risks that
could retard economic growth and put our projections at risk. However, our base
case view is that these risks are manageable and that the global economy should be
able to withstand any flare ups that might occur in 2015.

Number of Quarters of Expansion

Current Phase Is Getting Older At 21 Quarters

Oil Prices Reflect Excess Supply Rather Than Demand

150%

45

40

40

US Recession

WTI 6-Month % Chg

35

35

100%

31

30
25

24

Average

21

20

50%

20
15

14

13

0%

12
8

10

-50%

5
0
1950

1954

1958

1961

1971

1975

1983

1991

Starting Year of Expansion Cycle

Source: Bloomberg, Raymond James Ltd.

2002

2009

-100%
'83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13

2015 Market Outlook

January 5, 2015 | Page 7 of 8

Positioning
We continue to recommend a cyclical bias in portfolios with respect to sectors and
equity holdings. Cyclicals tend to outperform later in the business cycle, when
economic momentum is improving. With the Fed likely to hike interest rates in mid2015, as a result of stronger economic activity, we see the potential for bond yields
to rise which would likely be a headwind to interest-sensitive sectors such as utilities.
In the accompanying table we outline the rationales behind our sector
recommendations.
S&P/TSX Sector Recommendations For 2015
Sector
Financials

Consumer Discretionary

Canada (S&P/TSX)
Stance
Overweight

Overweight
( Market weight)

Rationale
Sector delivers steady earnings growth which could lead to higher dividends in 2015
Valuations are reasonable at 12.5x forward earnings and 1.8x P/B
Positive technical trends
Sector stands to benefit from lower oil and energy prices
Sector is expected to deliver strong EPS growth of 16% next year
Positive technical trends

Industrials

Overweight

Industrials stand to benefit from stronger US growth and capital spending

Sector is expected to deliver strong EPS growth of 24% next year
Positive technical trends

Information Technology

Overweight

Information technology sector is a good play on stronger capital spending

Sector typically outperforms when interest rates rise
Positive technical trends

Energy

Market weight
( Overweight)

Stronger US dollar and weak emerging market growth is a headwind for sector
OPEC decision not to cut production was a game changer for oil prices
Decent valuations and weak 2014 performance should limit downside

Consumer Staples

Market weight

Sector stands to benefit from lower oil and energy prices

Positive technical trends
High valuations at 21x forward earnings should limit upside

Telecom Services

Market weight
( Underweight)

Materials

Underweight
( Market weight)

Utilities

Underweight

Health care

Underweight

Earnings growth has begun to improve following weak 2012 - 2013 period
Technical trends have improved
Valuations are reasonable with sector trading at 16.9x forward earnings
Higher US dollar and slower emerging market growth are headwinds to commodities
Commodity indices and gold prices have broken below long-term uptrends
Negative technical trends
Sector is likely to be negatively impacted by rising interest rates
Sector is trading at 12-year high valuations at 25x forward earnings
Negative technical trends
Canadian health sector lacks breadth and depth - prefer US healthcare sector

Source: Raymond James Ltd.

Conclusion
We view the current economic conditions of not too hot, not too cold as being ideal
for equities and see continued gains next year. Improved economic growth should
result in stronger corporate earnings, while inflation trends remain benign, allowing
the Fed to be slow and gradual in raising interest rates. While we believe 2015 will
come with higher volatility for equity investors, particularly through the summer/fall
months, we see North American equities posting another year of positive returns in
2015, with the cyclical sectors leading the way.

2015 Market Outlook

January 5, 2015 | Page 8 of 8

Important Investor Disclosures

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