Improving profit margins and firm commodity prices have led to an increase to Russell Investments’ year-end target for the S&P/TSX Composite Index to 15,300 from 13,800.

“Our upgrade is not necessarily a reflection of being more or less bullish; rather, it’s a reflection of improving profit margins,” says Shailesh Kshatriya, associate director, client investment strategies, at Russell Investments Canada.

“While this shift occurred sooner than we anticipated, we believe the improving outlook is being supported by several notable trends, including rising oil prices, continued strong results from the banks and market multiples, which have been aided by the strength in the energy and financial sectors.”

Increased economic activity as the U.S. rebounds over the course of the year should also reinforce domestic trends, says Kshatriya. “As such, we no longer expect multiples to contract for the balance of the year, but remain stable. And pertaining to economic growth, we expect it rebounds from weak Q1 levels, finishing the year between 2% and 2.3%.”

At the same time, he suggests the market is susceptible to a mild correction before it moves forward, and remains cautious in the interim.

The Canadian dollar is in a losing battle and has tightened the fair-value range for the CAD/USD exchange rate to 0.89-0.94 USD per CAD, versus the prior range of 0.90-0.98. The days of the Canadian dollar trading near parity to the U.S. dollar are over, according to Kshatriya, and the loonie most likely needs to be lower for longer in order to improve competitiveness and add some life to the fading manufacturing sector.

For global equity markets overall, Russell’s strategists maintain a modest preference for equities over fixed income globally, though with a slightly diminished spread for the U.S. market. However, the combination of volatility near all-time lows (as measured by the VIX Index), investor complacency and stretched equity market valuations, is leading them to caution that the markets are especially vulnerable to shocks.

Russell predicts monthly gains in U.S. non-farm jobs to average 230,000 over the next 12 months and the U.S. Federal Reserve’s interest-rate hikes to be held off until mid-2015.

“Mid-year data points support our outlook that U.S. 10-year Treasury yields are likely to rise, default rates will stay low and support credit spreads, and equities can continue to outperform fixed income,” says Andrew Pease, Russell’s global head of investment strategy. “The CPI rise appears to be more noise than signal. Our models suggest core inflation will stay close to 2% through 2015.”

Russell’s strategists suggest the U.S. has become marginally more expensive as the market reaches record highs, with the cyclically adjusted price/earnings ratio for the U.S. large cap Russell 1000 Index at more than 20 times, and the price-to-book value is around 2.8 times.

They also see European equities as modestly expensive and score Japan’s valuation as neutral. Emerging markets remain undervalued by 30% to 40% relative to developed markets equities. They see business cycle indicators as positive for the developed economies, and they believe growth should strengthen across the United States and Europe over the remainder of the year but feel that uncertainty remains in other markets.

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