Hello, I’m Christine Wellenreiter, Vice-President of Marketing and Communications at GLC Asset Management Group. On today’s podcast we will be taking to Brent Joyce, GLC’s Chief Investment Strategist. Brent, – glad to have you on the line.
It is wonderful to be here with you again Christine.
1. Brent, you recently wrote an article on the 8 best reasons to like Canadian Equities. Why did you choose now to write that piece?
With YTD Canadian equity returns of just over 2% looking lack-luster, especially when people are hearing reports of new all-time highs in US stock markets, I am sensing a level of frustration with Canadian equities when I am having discussions with our clients. My concern is that people aren’t looking objectively at where things stand today, they may not be looking at the recent relative performance objectively and in light of moves we have seen in the currency. I see this leading to an overly pessimistic view of Canadian equities that I fear can lead folks to make what I believe are some poor investment decisions going forward. This is also borne out by the data we see, at the investment fund industry level, so far this year investors have been taking money out of Canadian equities.
I think people need to examine the facts as they currently stand, stay focused on their longer-term goals and think more about where opportunity may lie ahead, rather than lamenting the recent past. And we are just talking about the recent past. Canadian equities were a top performer in 2016 and when we account for the strong advance for the Canadian dollar, which ultimately impacts the returns Canadians see on their statements, since January 2016 the benchmark S&P/TSX Composite Index has delivered better returns for Canadian investors than the S&P 500 or the international equity benchmark of the MSCI Europe-Asia, Far-East Index. Only emerging markets have outperformed Canada and that is only in the past 7 months. The S&P/TSX Composite did reach a new all-time back in February and was the top performer of those four broad market indices at that time. Talk about a what have you done for me lately attitude.
But more importantly it is about the opportunity we see in Canadian equities going forward that prompted me to write the thought piece we just published.
2. Rather than go through all 8 reasons that you lay out as to why Canadian equities look good right now, I want to focus on some of the major themes you brought out within that article. Specifically, the relative value of Canadian stocks versus other options, such as US stocks for example, and then another major theme you bring up in your article - the role global growth is playing in terms of shaping your outlook for Canadian stocks.
So, starting with the discussion on relative value – that is, ‘what you are getting for the price you are paying’ - how do you see Canada stacking up versus its developed market peers, particularly the US equity market?
The argument for Canada based on relative value is pretty simple and concrete. Canadian equity dividend rates are more attractive than their US counterparts. The dividend yield of the S&P/TSX Composite is 2.8%.That’s 40% higher than the 2% dividend yield of the S&P 500.
Canadian equities are reasonably priced and valuations are attractive relative to US equities. Both 12-month forward and trailing price-to-earnings ratios for the S&P/TSX Composite are well below those of the S&P 500. In fact, the gap between the two sits near the widest levels post financial crisis (and outside of the financial crisis, it matches the widest levels in 15 years). Starting from these lower valuations when we model out 12-month forward return scenarios for both markets it results in greater upside potential for Canada
3. So, with that picture in mind, why do you think we’ve seen the US outperform the Cdn market so strongly in the first 3 quarters of 2017?
Ultimately, that boils down to the types of companies we have listed on our stock exchange that make up the index. In a nutshell, it is a result of what sectors have been in favour lately vs. those that haven’t been in favour and Canada’s weightings to those sectors. The sectors that have benefited most from this year are the information technology and health care sectors - both have been exceptional performers, not only this year, but the past 3-years. Unfortunately, the S&P/TSX Composite only has 4% exposure to these two sectors combined. Contrast that with the S&P 500’s near 40% weight and it goes a long way to explaining the Canadian market underperformance. Economic conditions are always shifting with no one trend will last forever. Investors need to be careful when things become too popular, we call that a crowded trade. Information technology and health care are crowded trades and that can become painful when the tide turns.
4. Okay, so let’s move on to global growth – in the article, you build a case for Canadian equities based in part on its relationship to the outlook for global growth, and you do so from several different and interesting angles. Prospects for global growth seem rather positive right now. Talk to me about how you see the current global growth picture contributing to your positive outlook for Canada equities, and just as importantly, your positive outlook for Canadian stocks relative to some other markets.
When we examine the data, we see many more indicators pointing to robust economic conditions than we do otherwise. And these favourable conditions are world-wide, we call that synchronized global growth. Forward looking measures of economic activity globally - things like Purchasing Managers Surveys, leading economic indicators, surveys of consumer and business confidence are all signaling growth ahead. Consider that for the first time since 2007, not a single one of the 35 countries in the Organization for Economic Cooperation and Development, the OECD, is in recession – this is a mix of developed and developing economies. Furthermore, roughly 2/3rds of those 35 countries are estimated to see accelerating growth. This may not seem like much, but this kind of synchronized global growth is rare. The world hasn’t witnessed it since 2007, and prior to that only once in the early 1970’s and late 1980’s – in all previous cases strong Canadian equity performance ensued.
This kind of backdrop should be supportive of commodity prices and should be accompanied by rising interest rates. Now here’s where we get back to the Canadian sector weights we discussed. What has been holding Canadian equities back is precisely the thing that I believe will turn from a headwind to a tailwind.
The sector weights of the S&P/TSX Composite have a strong cyclical growth orientation and tend to do well in periods of global economic expansion, when both interest rates and commodity prices are on the rise. Recall we have only 4% exposure to information technology and health care, but the financial sector is the largest weighted sector at 34%, and banks and insurers tend to benefit from higher interest rates. On the commodity front, we have 20% exposure to energy and 12% exposure to materials, metals and mining.
Other markets have these companies too, but not too the same degree, the S&P/TSX Composite has 20% more exposure to rising interest rates and increasing commodity demand than any other developed market.
But our market isn’t the only one that performs well under this kind of synchronized global growth backdrop. When we look at emerging markets for example, they too are levered to this global growth environment and here we see a large disconnect. Since the spring of 2017, emerging markets that were tracking closely with Canadian equities have continued to fare well, whereas Canadian equities went sideways. The result is a gap of over 12% has opened up between how emerging markets and Canadian equities are responding to the global economic growth backdrop. These types of inconsistencies don’t tend to last forever in the marketplace, and we expect Canada to catch up and narrow this gap.
5. Brent, I can hear it in your enthusiasm that you are bullish on Canadian equities, and as we just learned, for a number of good reasons. But let’s be clear, you aren’t telling people to abandon the idea of a diversified portfolio – one that includes some asset class and regional diversification.
Absolutely not, it is about managing emotions and behavior, in light of the recent experience, and not letting those emotions cloud your judgement going forward. The lack-luster performance of Canadian equities has certainly tried the patience of investors, but looking forward to where tomorrow’s gains may come from leads us back to Canadian equities as being well positioned for growth.
If you are an investor who likes to buy on the dips to rebalance your portfolio, we think Canadian equities should be on your radar. Canadian equities declined 6.1% from February to late August 2017. September’s near 3% return for the S&P/TSX Composite is consistent with our views, and represents a positive shift in sentiment toward Canadian equities.
Most importantly, we encourage investors to refrain from chasing past performance. As asset prices have shifted, balanced portfolios shouldn’t abandon core positions and they may need re-examining to rebalance back into assets that have underperformed.
Good advice! Thank you Brent, you raised a lot of good things to think about and consider as investors review their long-term investment plans. If investors want to read all eight reasons you work through on why Canadian equities are looking good, where can they find that?
(GLC’s website and LinkedIn page. GLC’s most recent Insight piece called GLC’s 8 best reasons to like Canadian equities)
Brent, I look forward to the next time we speak and hear your views on current market events and conditions.
Read our market commentary: Eight reasons to like Canadian equities
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