TD Waterhouse today updated its investment forecast for the balance of 2006, which re-iterates the six dominant themes the brokerage firm emphasized in January.

First, TD Waterhouse’s outlook for Canadian and U.S. equity markets, which in January had called for a fourth consecutive annual advance and mid-single digit returns on both sides of the border in 2006, remains unchanged. “The S&P/TSX Composite rose 3.02% in the first half of the year while the S&P 500 was ahead 1.76%, so we are on track”, said Bob Gorman, chief portfolio strategist of TD Waterhouse, in a news release.

“Meanwhile, the positive and negative factors affecting stocks are little changed”, said Gorman. Valuations remain reasonable, with P/E multiples in the 15-17X range and earnings growth, while slowing, has remained solid. One issue is monetary policy in the U.S. with the possibility the Fed Funds rate will increase further, coupled with weakness in the U.S. housing sector, which portends slower growth in the second half of 2006.

In the medium term, TD Waterhouse expects U.S. short-term interest rates will likely plateau in the fall and begin to ease later this year or early next under the weight of a slowing U.S. economy.

Second, TD Waterhouse indicated in January that U.S. small caps would under-perform in 2006. While shares of smaller U.S. companies started the year strongly, their benchmark Russell 2000 Index slid 5.29% in the second quarter, versus a decline of 1.91% by the S&P 500, in anticipation of tightening credit and a U.S. slowdown. Small caps continue to lead their larger, S&P 500 counterparts for the year to date but TD Waterhouse expects that margin to dissipate as the year wears on.

The third theme forecast in January was a rotation of U.S. market leadership into defensive, large-cap stocks. This unfolded in the second quarter’s turbulence as investors shifted into companies exhibiting the consistent sales, earnings and dividend growth. During the coming, choppy markets, TD Waterhouse expects this trend to continue. In the U.S. the defensive, consumer non-durable goods stocks – personal products and soft drinks, for example – should continue to fare well. In Canada, the major insurers remain favourites.

Fourth, TD Waterhouse’s January forecast called for a continued flattening of the yield curve with bond returns approximating 4% in 2006. The yield curve has indeed flattened further and Canadian bonds have, in fact, had modest returns in the year to date as bond yields have risen. As evidence mounts of slower economic growth, TD Waterhouse expects bond yields to decline slightly, which should result in returns at or close to the forecast level.

Fifth, income trusts’ total returns were to be lower in 2006, as capital gains diminished and distributions comprised a higher portion of total return. As well, the division between strong and weak income trusts would become more pronounced as a number of lower calibre income trusts would find it increasingly difficult to meet their aggressive distribution targets. Both elements of this forecast have been accurate to date and the same trends should play out over the balance of 2006.

Finally, Japan’s Nikkei Index was forecast to out-perform the U.S. stock market for the third consecutive year. This was predicated on Japan’s role as the leading exporter to China, strong corporate profit growth, reasonable valuations, an improving banking sector and better political environment. From January through April, the Nikkei Index had risen about 1,000 points to the 17,100 level but has fallen back in recent weeks on concerns surrounding export prospects in light of a likely U.S. slowdown and the North Korean sabre rattling. These concerns seem overdone and we expect Japan to perform in line with our forecast in the months ahead.