Have Canada’s stocks fallen enough to be value plays?

Ttake one

YES, FEARS OVERBLOWN

Despite all the bad news coming from the resource sectors, Canada’s

companies aren’t doing too poorly

he bear market in oil and other commodities, an economy in a technical recession, and a very expensive housing market are just some of the reasons why investors might avoid Canadian stocks. But the broad equity market selloff that spared no sector wasn’t driven by fundamentals.

Take real estate. Worries about a potential bubble bursting have put pressure on Canadian bank stocks. But unlike energy-related segments of the economy, housing is showing no signs of a recession. “If this ends up being a ‘recession,’ it will be the first one ever that did not see the consumer, housing or employment go down for the count,” noted David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc. Housing starts exceeded expectations by a healthy margin again in August, and the long-standing fears about the over-leveraged Canadian consumer have failed to put a dent in the rabid demand for homes in most markets.

Meanwhile, the carnage in the energy sector hasn’t produced severe loan losses on Canadian bank balance sheets, suggesting the primary reason investors aren’t buying is fear. Even the hedge funds betting against the sector appear to have faded into the background.

Yields on bank stocks kicked to the doghouse get even more hefty, and Canadian players aren’t doing all that poorly considering how challenging global capital markets have been. “Investors are still waiting to assess the full extent of the blow from crude on bank earnings going forward, but solid core operating results, and generous dividend yields still make TSX banks an attractive area of the composite,” noted Nick Exarhos, an economist at CIBC World Markets.

But investors in Canadian equities are still worried about the contagion risk associated with lower energy prices, emerging market weakness, and U.S. Federal Reserve interest rate policy. Brian Belski, chief investment strategist at BMO Capital Markets, believes those concerns are overdone. “Many investors remain too focused on the strategies of the last decade,” he noted. “As such, we believe the market is in the process of carving out a bottom.” — Jonathan Ratner

Ttake two STEER CLEAR Canadian stocks have collectively been dismal, but they are doing worse than many investors think

hinking of adding companies to your portfolio? If so, steer clear of Canada. The S&P/TSX Composite Index has been a dismal performer, but it’s even worse than many think. If you eliminate red-hot health-care stocks such as Valeant Pharmaceuticals International Inc., the TSX has been one of the world’s worst-performing stock markets this year and the numbers suggest there is more pain to come.

For one thing, the energy sector, which accounts for slightly more than a quarter of the TSX, has significantly pulled back in the past 12 months, but still trades at a whopping 30 times forward earnings. That suggests there is much more pain to come as markets keep adjusting to analyst cuts in earnings expectations.

Meanwhile, the Canadian economy fell into a technical recession (defined as back-to-back quarters of negative growth) in the first half of 2015. Even the weak loonie, which some hoped would spur a manufacturing and export boom, has failed to kickstart growth. The Bank of Canada earlier this year said that it was “puzzled” at the lacklustre pace of exports, which are still below their post-recession high reached last year. That precarious economic backdrop has led to a lot of questions about Canada’s housing market, where sales and prices continue to defy gravity. Since many stocks are tied to the country’s housing market or commodity prices, there are few choices left, and even those are likely to experience profit pressures as the Canadian economy staggers along.

A cloud of economic uncertainty hangs over Canada and its companies and some economists are convinced that more pain lies ahead, perhaps necessitating further rate cuts from the BoC. “We still anticipate that further weakness in energy-related business investment, combined with an underwhelming performance from non-energy exports and signs of weakness in housing, will eventually prompt the Bank to cut rates by an additional 25 basis points to only 0.25%,” said David Madani, an economist at Capital Economics.

That kind of gloomy outlook suggests investors should stay away from Canada for now. — John Shmuel