Forget 16,000.
Investors, passive or active, want to know if the S&P/TSX Composite Index (TSX:^OSPTX) is going to 17,000 in 2017 or if it will retreat to the mid-14,000s, where it traded as recently as November.
So far this year, the index is up 1.5% through March 3 — 450 basis points fewer than the S&P 500 Index in the U.S. It’s got some work to do if it wants to catch up.
What should investors on this side of the border look for in terms of valuation metrics, economic indicators, and company news that would help determine if the S&P/TSX Composite Index is up to the task of blowing through 16,000 and hitting 17,000 by December 31? Here are some suggestions.
P/E ratio
Edmonton chartered financial analyst Shawn Allen runs InvestorsFriend, a website dedicated to providing transparent investment advice. One of the things Allen does on a frequent basis is to come up with a fair value for the S&P/TSX Composite Index based on the index’s earnings and dividends today and in the future as well as the minimum return required by investors.
For example, if investors require a 7% return on equity, and the index is able to deliver 9% returns on a sustainable basis, the P/E would be higher than if it were only able to deliver 5% returns.
As of November 2016, Allen suggested that the index’s P/E ratio was somewhere between 14.3 and 16.7, which put the fair value of the index at 13,980 — 6.9% lower than its November 29 level at 15,008. It’s up 3.9% since then; a whole lot would have had to change between then and now in terms of earnings to alter this scenario.
However, as Allen would remind you, valuing the S&P/TSX Composite Index is not an exact science, so although his math sees an overvalued index, that doesn’t mean everyone else does.
Economic indicators
The index hit its all-time high of 17,729.12 on February 10. At that time, the March crude contract hit US$53.86 a barrel, which was down from the $57-per-barrel asking price in mid-December, but still well above prices a year earlier.
Given the index’s reliance on energy stocks, any push higher in the price of oil will drive the index higher as earnings from those companies improve over subsequent quarters.
While it’s important for investors to keep an eye on the price of a barrel of oil, it’s also important that they consider what kind of job the index’s energy components have done reducing their costs over the past 12-18 months. There are oil and gas producers, Fool.ca contributor Nelson Smith reminded readers in January, who’ve cut the cost of producing a barrel of oil to the point where they can make money at oil prices south of $50.
However, there are other economic indicators to follow, such as the growth in GDP, the job situation, including wage growth or lack thereof, inflation (excluding energy prices), interest rates, Canadian dollar, etc.
While the markets could still go higher despite all of these being negative, it’s highly unlikely.
The trend is your friend
Once the market gains momentum, it’s pretty hard to stop it. Whether upward or downward in nature, you generally are unwise to bet against a market in motion.
“Historically, when markets do hit new record highs, they tend to hit more new record highs,” Michael Currie, vice president and senior investment adviser with TD Wealth said in the Toronto Star recently. “It’s a sign of better things to come.”
Continue to look for the index hitting higher highs and lower lows, because that will tell you it’s moving higher in the near term.
Bottom line
If you’re thinking about investing in the S&P/TSX Composite Index through the iShares Core S&P/TSX Capped Composite Index Fund (TSX:XIC) or one of the other TSX-listed ETFs that tracks the index, remember that evaluating an index is very similar to analyzing a stock.
You’re looking for reasons why you should or shouldn’t make that investment based on the facts available at a given time.
