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U.S. equities regain their sheen for Canadian investors

Canadian investors can dodge the China factor by diversify in U.S. stocks in non-resource sectors

From Wednesday's Globe and Mail

17:48 EDT Tuesday, April 03, 2012

The Canadian and Australian stock markets hold a dubious distinction: Among the world’s biggest bourses, they’re posting the two worst performances so far this year, excluding luckless Spain, which has its own well known problems.

The role as stock market laggard isn’t something that investors in the two countries have experienced much of in recent years, but it’s likely that they’re both suffering from the China factor. Slowing growth in the Asian economic powerhouse is affecting resource demand, harming equities on exchanges dominated by materials companies.

The economic risks that Australia faces as a kind of Chinese economic colony for raw materials is appreciated by the market. Canada’s similar position as an indirect China play isn’t as well known, but there is an easy step Canadian investors can take to dodge the effect: Diversify by holding more U.S. stocks in non-resource sectors.

Until recently, Canadians could be both smart and patriotic when it came to stock selection, buying domestic equities because they made the best investments. The U.S., mired in a deep, economic malaise with dysfunctional politics to boot, was easy to avoid. But this line of thinking no longer makes sense, at least according to Odlum Brown, the Vancouver based investment dealer.

It believes U.S. equities are now far more compelling than their Canadian counterparts. “The Canadian market has done a whole bunch better than the U.S. market for the better part of the last decade and we’ve gotten to a point where valuations are simply a lot better south of the border,” says Murray Leith, Odlum’s director of research.

Canadians have been so used to their market outperforming its U.S. counterparts that it may come as a bit of a shock to find the extent that gains have been dramatically in favour of the United States.

In a note to clients, Mr. Leith did some number crunching that shows just how smart it is to get some money out of Canada. Over the past twelve12 months, Canada’s benchmark S&P/TSX composite index has fallen about 11 per cent, while the S&P 500 has risen more than 9 per cent.

The gap of 20 percentage points in relative performance between the two countries is “massive,” he says, and reflects “a new goldilocks” economy that favours the U.S., as a relatively decent pace of growth south of the border isn’t so strong that it prompts stock-harming inflation.

Moreover, Mr. Leith contends that slowing growth in China may actually be good for the U.S. because it takes some of the pressure off commodity prices, thereby helping corporate profit margins and consumer spending. By contrast, a slowdown in China is an unambiguous negative for commodity producers.

Convincing Canadians to diversify into the U.S. has been difficult because most investors remain fixated by nearly 10 years when domestic stocks did better than those in the United States.

Canadians diversified into the U.S. in the late 1990s, at precisely the wrong time. Back then, the dollar was under 70 cents U.S., technology stocks were booming to absurdly overvalued levels, and no one wanted to buy the then-bargain-priced Canadian natural resource companies.

“Canadians were tripping over themselves to get money out of the country” back then, Mr. Leith says.

Now, however, the idea of diversifying makes a whole lot more sense. Canadian and U.S. dollars trade around par, so there isn’t a big currency hit. The shares of many big-name U.S. companies represent decent value because their share prices haven’t appreciated much over the past decade, even as their earnings per share have improved.

“There are some really big, great companies that have been neglected for a long time,” Mr. Leith says, citing 3M Co., General Electric Co., United Parcel Service Inc., Coca-Cola Co., and Colgate-Palmolive Co. as typical examples.

Value has been building up in U.S. banks too, but getting domestic investors to consider buying them has been tough because “Canadians love their Canadian banks,” he observes.

Currently, Odlum has only U.S. megabank JPMorgan in its model portfolio of preferred investments, but other names are under consideration.

Mr. Leith doesn’t want people to get the wrong impression that he’s anti-Canadian. He doesn’t “think things are horrible for Canada.” It’s just that “at the margin,” investments in the U.S. are “looking more attractive” at the moment.

He also says there will be a silver lining for Canadian stocks as the U.S. economy continues to improve because it will offset some of the impact of the slowdown in China and other emerging markets.




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