CANADIAN EQUITIES ARE DUE FOR A COMEBACK
As artificial market stimulants fade, expect stock pickers to revert to more traditional measures for valuing companies
Not since 2009 have investing pros gone into a year with as much trepidation as they feel today. And unlike 2009— which, you’ll recall, turned out to be a pretty fantastic year for equity investors—markets for most investable assets are still looking down from what would seem to be lofty heights.
“We expect little or no price appreciation in fixed income and only muted gains for most equity markets in 2016,” stated strategists from BlackRock Inc., the world’s largest investment manager, in their outlook for the coming year. The report concluded that valuations for most asset classes have moved ahead of actual business results. “We have essentially been borrowing returns from the future,” the report said.
Among all the unappealing options, however, Canada’s stock market actually looks darned attractive—at least from a quantitative perspective. Consider the cyclically adjusted price-to-earnings (CAPE) ratio. This measure, popularized by Nobel laureate Robert Shiller, compares a stock’s market price with its annualized earnings per share, not just over the past four quarters but over the past 10 years. Shiller theorized that it was a more accurate measure of relative valuation than one-year trailing price-to-earnings.
The CAPE multiple for America’s S&P 500 is currently sitting around 22.3, which is well above its historical average of 16.4. In Canada? The S&P/TSX composite index stands at 17.8, below its long-term average of 19.3. Given their profitability through more than one business cycle and compared with U.S. issues, in other words, Canadian stocks are on sale—30% off. On that basis, German investment firm StarCapital AG forecasts returns of 6.2% a year in Canada over the next 15 years, and just 3.6% in the U.S.
Now consider the fact that the S&P/ TSX Composite has underperformed its American counterpart for five years running. That is the longest consecutive stretch of underperformance since 1970. (The previous record was the four years from 1989 to 1992.) If you believe the Canadian and American economies and capital markets are broadly similar, just skewed toward different industries and sizes of enterprises—and we do— then it’s high time for the pendulum to swing the other way and for capital invested in Canada to begin earning a higher return than in the U.S. That’s the way free markets work.
Canada’s long track record of market efficiency, transparency, the rule of law, and consistent and predictable regulation that’s similar to the U.S. gives us confidence that the market’s valuation will indeed revert to the mean—maybe not this year, but over the long term.
One thing investors in all financial assets should keep in mind is that, as Bill Clinton’s presidential campaign used to remind itself, “It’s the economy, stupid!” The unseasonal tailwinds that have supported stocks since 2009, such as quantitative easing and share buybacks financed by ultra-low borrowing costs (and bonds, namely a 30-year supercycle of falling interest rates) have blown themselves out. Sustainable share price increases henceforth will come from one thing and one thing only: earnings growth.
Even in the miserable year for the markets that was 2015, some Canadian large-caps managed standout earningsper-share growth: George Weston, Element Financial, BlackBerry, Constellation Software and Emera. You’ll have to do your own due diligence as to whether these or other stocks meet your personal selection criteria when you’re ready to buy. But stick with organizations that continue to grow their businesses profitably—despite it all—and you can’t go too far wrong.