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Canada on sale?

TSX lags behind U.S. counterparts, but bargains depend on natural resources' future

Hey there, time traveller!
This article was published 26/7/2013 (1487 days ago), so information in it may no longer be current.

It seemed only a short time ago everyone was discussing the demise of America. China and India were ascending as U.S. economic hegemony seemingly faded into history.

How things have changed.

Today, the U.S. is healthy by comparison to many other economies. By no means is it a well-lubed engine, but its recovery in the last couple of years has drawn investors back.

And in return, they have been well-rewarded. In contrast, Canada -- by no means mired in recession as is Europe -- has muddled along, in large part because our economy sails by the tailwinds of a thriving global marketplace hungry for our abundant natural resources.

As a result, our stock market has lagged behind the U.S. While the Dow Jones industrial average and the S&P 500 have reached record heights, Canada's stock market has struggled.

Trading in the 12,700 range, the TSX Composite is still far from its peak of 15,073 in June 2008, about four months before the big crash.

Certainly, Canada's stock market has plenty of potential, an access point for investment in firms that produce oil, gas, copper, nickel, potash and many other materials the world needs. Given this promise, an investor might speculate our stock market is an overlooked, undervalued jewel.

But whether the Canadian market is on sale or not boils down to your take on commodities.

If your viewpoint is prices for oil, gas and other materials will rise substantially over time, then the TSX will fulfil its bountiful promise because many companies listed are involved in resources extraction. But if you foresee slow growth, with demand for resources remaining steady, the TSX may continue to lag behind the U.S.

Yet, while Canada has underperformed the U.S. market in the last few years, so, too, have most other markets, says Tony Demarin, financial analyst and president of BCV Financial in Winnipeg.

And although the overall performance of the TSX has been somewhat lacklustre, many Canadian companies have done very well lately.

The share prices of companies such as CN, CP, Shoppers Drug Mart, Tim Hortons, Manulife and Magna have gained in price considerably in the last few years. A good number are even trading at all-time highs.

Yet these firms make up a small fraction of the index compared to resource-based firms.

"The challenging part of the Canadian equity market has been the huge resource sector, such as gold, materials, energy -- at least most of them -- and agriculture, like Potash Corp," Demarin says.

Commodity prices are cyclical in nature. They tend to boom and bust, and they're slowly recovering from the collapse in the fall of 2008 after reaching record highs earlier that year. Because so many Canadian companies' fortunes are tied to commodities, the overall index has been sluggish. Even our bastions of financial stability, the banks, which haven't done poorly, are of concern to some investors. That's because while commodities have muddled along, the housing market keeps climbing.

But after years of growth, there's only so much more real estate can grow, and that affects banks because a large chunk of their revenue is tied to interest earned from mortgages and home-backed lines of credit.

While Canada's real estate market's effervescent qualities concern some investors about the banks' ability to continue earning high profits, many are also concerned about our market's lack of variety. Canada is not well-diversified compared with the U.S., says Norman Raschkowan, chief North American investment strategist for Mackenzie Investments.

"The reason the Canadian market has underperformed the U.S. market so much is really because energy and even more so materials -- gold and other mining -- are such a big part of the Canadian index and such a small part of the U.S. index," he says.

"When you look at it sector by sector, there are some opportunities in the Canadian market. Excluding commodity-related companies, Canada's market doesn't look that out of line from the S&P 500 in terms of performance," Raschkowan adds.

Consumer discretionary stocks are actually up about 20 per cent on the year and technology companies are also performing well. The problem is they're a very small percentage of Canada's overall market.

Economists at TheStreet -- a U.S.-based investment news website -- such as Joe Deaux say investors outside Canada simply see the U.S. market relative to Canada as a better place to invest their money.

"That doesn't mean that they don't think there's value jumping into the Toronto Stock Exchange, but what it does say is investors go where they can find the highest yield and right now, that's still the U.S. markets."

Deaux says a number of factors are contributing to the health of America's publicly traded markets. But one of the main drivers is the Federal Reserve.

While the Bank of Canada engages in accommodative policies, such as lowering the prevailing rate to one per cent, the U.S. central bank has engaged in much more aggressive strategies to stimulate growth.

"There has been significant monetary policy that a lot of people will call 'loose,' " Deaux says.

For example, the Fed has been buying $40 billion of mortgage-backed securities a month to prop up the ailing housing market. It has also been purchasing long-term treasuries (bonds) to drive down yields, forcing investors to seek better returns in riskier, higher-yielding assets such as the stock market.

But this policy has its drawbacks. The mere hint of pulling back on stimulus, as we've seen recently, can send markets downward. Yet, ironically, the longer stimulus is in place, the more likely in the long term the U.S. will suffer from higher-than-normal inflation, which can also negatively affect markets.

In the short term, however, the Fed's policies are helping fuel the recovery. As a result, investors are more confident in its markets and its currency.

Incidentally, that confidence on both fronts has helped drive down the price of gold of late, which in turn affects the TSX, where many of the world's largest gold companies are listed.

And while oil prices are rebounding, Deaux says Canada's energy sector still is a bit of a question mark because of the uncertainty surrounding the oilsands and the proposed pipelines to bring bitumen to markets in the U.S., China and Eastern Canada.

"But I don't think you're going to see some huge drop-off in the Canadian market," he says. "It could be that right now the Canadian market will plug along."

Over the decades to come, however, Canada's stock market has plenty of potential to be profitable. That is if you subscribe to the theory the populous emerging markets will resume their ascent to the top of the economic food chain and will need the resources we have in so much abundance.

Although emerging markets have not performed well lately, it's likely they will start to heat up again as other economies such as Europe's recover and demand for consumer products starts ramping up, jump-starting the economies of China, Brazil, India, Indonesia and others, Demarin says.

"Until that time arrives, though, the U.S. will continue to outperform with its much larger industrial, technology, health-care and consumer sectors and much smaller resource sectors."


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