There's No Place Like Home: Canada Is Where Equity Investors Should Put Their Money

According to a new report by CIBC World Markets Inc. Canadians are turning their focus to building up their financial assets and would be wise to invest their money at home.

The report notes that with bonds in what looks to be a longer-term bear market, investors will be looking to equities to bulk up their retirement nest eggs - with Canadian stocks likely to produce the best returns. Unlike the U.S. and Europe, government debt and subsequent fiscal belt-tightening will not be as a big a drag on the economy in Canada. The rising inflation concerns in the emerging markets economies that are threatening to bring about higher interest rates to slow growth, are also not as much of a concern here.

"A diversified portfolio is always wise, but in terms of allocations for Canadian equity investors, it may well be that there's no place like home," says Avery Shenfeld, chief economist at CIBC, in his latest Economic Insights report. "Relative to the U.S. or east Asia, Canada's equity market carries more insurance against a worsening geopolitical climate in the Middle East, in the form of a larger basket of energy stocks and safe havens like gold shares.

"Inflation hasn't run away to the upside, so the Bank of Canada can chart a more careful course of tightening than what might end up being seen in the emerging market economies. The nation's fiscal position, while still in need of growth-slowing belt tightening, isn't as strained on either a deficit/GDP or net debt/GDP basis as that of the U.S. or Europe."

Mr. Shenfeld also notes that Corporate Canada is in good shape with TSX earnings having considerable momentum. He adds that the bank's new Leading Indicator of TSX Earnings (LITXE) indicates room for further profits ahead. The index is based on nine economic and financial variables that have foreshadowed index earnings movements for key TSX members. It was designed to provide investors with a forward-looking take on a critical driver of market performance, over a 12-month time horizon.

The value of the LITXE as of December 2010, the last date for which sufficient component data is available for calculation purposes, was 79. While not quite as high as the peaks seen prior to the recession, it is somewhat above the level three to four months ago, reflecting positive movements in several variables, including those for U.S. growth and commodity prices.

"Historically, a reading in this range has equated to yearly earnings growth in the 20-25 per cent range, well above the long-term average and only slightly less than the current bottom-up consensus," says Peter Buchanan, senior economist at CIBC. "While stocks are by no means as cheap as earlier, above-trend earnings growth should continue to provide the market with some support."

Analysis of past trends shows that over three quarters of the variation in year-to-year returns on the TSX is tied to variations in earnings expectations. The balance reflects the impact of interest rates and other factors on the earnings multiple—or amount that investors are willing to pay for a dollar of future earnings.

The TSX Composite is about four times as resource-intensive as Canadian GDP, and its mean book value of around $4 billion also far surpasses the Canadian business norm. As a result, CIBC's LITXE is heavily weighted towards oil and gold prices, given the importance of those two components in the index.

"The results also corroborate our past research, suggesting that earnings and the market take their main cue from offshore activity—U.S. GDP, in this case—as opposed to domestic trends," adds Mr. Buchanan. "Canadian stocks are more a bet on global economic conditions than those closer to home."

Mr. Shenfeld has raised his oil forecast for 2011/12 in light of political risks in the Middle East and North Africa. "The spread of Middle East unrest to an OPEC cartel member—albeit one whose production is just half of Canada's—has seen oil prices attain the highest levels since mid-2008. Market conditions, however, are not as tight as they were back then. OPEC now has around 5 million barrels of spare daily capacity, versus a million barrels two to three years ago, and industrial country stocks remain ample."

He expects a one per cent downshift in global growth this year as emerging markets tighten which will see a moderation in the growth of world oil demand. "We expect prices to fall by $10-15 a barrel when the tensions in Libya eventually ease, leading investors to refocus on fundamentals. But the recent spike could persist longer than expected if incoming regimes prove hostile or unstable, or if violence spreads to more significant oil producers."

Based on a massive 2010 Q4 inventory drag, Mr. Shenfeld now expects 2011 Q1 growth in the U.S. to come in at 4.1 per cent, upping his full year 2011 forecast to 2.8 per cent. "The extension of fiscal stimulus and a likely rebound in the labour market should help support consumption spending and offset the drag from the energy price spike, while business investment should get a boost from capital write-offs.

"However, we remain below consensus on growth from mid-2011 on as fiscal policy tightens and the savings rate rises on falling housing wealth. The persistent strength of energy prices warrants an upward revision to our headline inflation forecasts, although a much milder core rate will remain consistent with a no-hike policy from the Fed."

View the complete CIBC World Markets report.


on February 28, 2011