Signs suggest Canadian stocks are poised to gain altitude
What goes down tends to come up
The past couple of years have been tough ones for investors in Canadian stocks. While a key measure of U.S. stock prices, the Standard & Poor’s 500 index, surged ahead by more than 25 per cent over this period, Canada’s S&P TSX Composite index, actually fell about five per cent.
This year has followed the same discouraging pattern, with our laggard equities edging up by two per cent while U.S. stocks powered ahead 19 per cent.
But it’s important to remember the context. Canadian stocks had soared far above their U.S. counterparts for most of the preceding decade, propelled by a spectacular upsurge in resource demand. An experienced analyst will tell you that any such boom will probably be followed by something of a bust. It’s called reversion to the mean. In plain English, what goes up, up, up usually comes down.
In Canada, many of the same stocks that once helped fuel the rocket ride have slumped. One striking example: Canada’s gold sector, a big chunk of the resource sector in this country, is down a stunning 40 per cent so far this year, notes economist Robert Kavcic at BMO Capital Markets. Petroleum stocks have done better, but not nearly as well as their U.S. competitors, which have lower production costs.
As well, Canada’s big banking sector has looked like a laggard, even though it hasn’t done that badly. It’s just that Canadian banks can’t match the remarkable gains of their U.S. counterparts, which are rebounding from their neardeath experience during that country’s financial crisis and housing crash. Since we didn’t have the crash, we couldn’t expect this bounce.
But reversion to the mean works both ways. What goes down tends to come back up. And now, there’s finally reason to believe that Canada is poised to enjoy this happier part of the economic cycle.
We may not return to outperforming the U.S., but there are a number of signs that Canada’s economy is about to gain altitude, helping to push up stock prices, sug- gest economists Avery Shenfeld and Peter Buchanan at CIBC World Markets. That improved outlook isn’t showing up yet in stock prices, Shenfeld said Friday, but he wouldn’t be surprised to see such a revival before the end of this year.
What’s his scenario? Basically, it’s that the global economic outlook has been so gloomy for so long that we’re past due for some pleasant surprises.
As a big exporter, Canada is heavily dependent on the health of the world economy. Now there are hints of improvement i n both the U.S. and Europe, Shenfeld believes. As well, he suspects most forecasters overestimate the impact of China’s current economic slowdown.
Most important, of course, is the U.S., which takes the bulk of Canada’s exports.
The economic numbers out of that country have remained disappointingly weak this year, but we can chalk this up to self-inflicted wounds imposed by a dysfunctional political system that hit Americans with an ill-timed tax hike followed by across-the-board federal spending cuts.
One result was that growth in the world’s biggest economy sputtered in the year’s first half. But more significant is that it managed to grow at all in spite of such battering.
This suggests underlying strength, driven by a resurgent housing sector, that will bring accelerating growth now that the fiscal damage has been absorbed.
Europe, which also suffers from unwise government austerity, is slowly turning away from this failed policy, suggesting that next year will see a return of growth after years of decline.
And China should be able to capitalize on renewed vigour in the U.S. and Europe to benefit from revived exports, offsetting strains in its domestic economy.
If you’re an index investor, the take-away is there will probably be decent capital gains in store for investors in the Canadian equity market for the first time in years.
If you’re more of a stock picker, Buchanan suggests focusing on issues that tend to benefit the most from U.S. growth yet are resistant to currently rising interest rates on bonds.
These include railways, energy companies and base metals.