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Canada & the USA, a Tale of Two Economies
In This Issue: Canada Lags: A “decade long” trend of
Canadian economic outperformance versus the US has been broken.
Good Value: The Canadian stock market
is exhibiting signs of good value after lagging US markets for the better part of two years.
Jobless Recovery: The legacy of the
last recession has left US corporations more efficient and without the need for large pools of the labor force. recently, however, a pronounced divergence has emerged with Canadian stock markets remaining relatively flat over the last year as US stocks marched higher. This disconnect is illustrated on the following page.
Canada Out-of-Step With the US
hen two countries are as interconnected as If one were to search for an explanation for this diverCanada and the US, it is often the case that gence then the fundamentals of the Canadian econtheir respective economic circumstances are at omy and slowing global commodity prices are a great least somewhat similar. For these two place to start. One of the biggest reasons As we had indiNorth American neighbors, however, for this underperformance has to do with cated .. economic the makeup of the two countries’ markets. their economies and stock markets have diverged considerably over recent indicators were al- Approximately 40% of the Canadian stock months. This shouldn’t come as too ready signaling a market is made up of natural resource much of a surprise, as we had indistocks - more than double the 15% reslow down in cated in our last newsletter that leading source exposure of the S&P 500 (US Canada’s economy. economic indicators of each economy Stocks) . were already signaling a slow down in Canada’s Decade of Success Canada’s economy and a much awaited resurgence of the US. For much of the last decade, rising commodity prices were a strong tailwind to Canadian equities. The world It is important to point out that stock markets are was knocking on Canada’s door. The allure of the only a partial reflection of the overall economy. riches of the Canadian oil sands, robust commodity And despite ebbs between the performance of Caconsumption from China and an appreciating Cananadian and US economies, historically their two stock markets have been highly correlated. More
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pact. Estimates indicate losses due to the discount in pricing to be upwards of $15 billion to $18 billion per year. This issue will likely continue to confront our oil producers for some time as pipeline capacity will continue to be constrained even if the Keystone XL pipeline wins approval later this year from the Obama Administration. The 830,000 barrel/day pipeline would not start moving oil until late 2014 at the earliest. The chart to the right illustrates its proposed route from Hardisty Alberta to Cushing Oklahoma. As investor confidence has been jarred by the developments in the Canadian oil sector, it has left many of the largest oil producers in Canada trading at very cheap valuations – rivalling the levels reached during the recession. These valuations plus their strong track records of dividend growth has made them very attractive investments. After releasing first quarter 2013 earnings, Canadian energy giants, Suncor and Canadian Natural Resources raised their dividends by 54% and 21% respectively.
dian dollar made Canadian equities attractive assets. As this went on, the capital inflows into Canada from around the world made Canadian equities even more attractive.
The Energy Sector
The Canadian energy sector, which comprises over 25% of the S&P/TSX index, has in large part acted as an anchor on Canadian equities. While the price of oil has stayed relatively high, Canadian oil companies have not been able to
benefit as much as their US counterparts. In fact, for much of 2012, Canadian oil companies were receiving up to $20/barrel less for oil shipped to the US. This was due to limited US The catalyst to unlock this value and move refinery capacity, pipeline con...many of the largest stock prices higher will come from the apstraints, and rising US oil production oil producers in proval of new pipelines that will move Canathat combined to create a glut of oil. Canada are trading dian crude faster to the US Gulf Coast, EastProfits for the Canadian energy secern Canada and to the Pacific Coast where at very “cheap” tor declined by more than 50% in Canadian oil companies will be able to acvaluations... 2012, to a little more than $7 billion cess Asian markets. The access to Asia is which is on par with 1999 levels. As especially important as US energy production the sixth largest oil producing nation in the world, continues to rise and China assumes its expected the discount that Canadian oil companies receive title of world’s largest oil importer. According to the on their crude production has an economic imInternational Energy Agency, US production of oil
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When the Great Recession ended in 2009, Canadian banks were trading at a significant premium to banks in most countries. Gradually, the rise in the stock prices of US banks has helped to narrow the valuation gap between Canadian and US banks. In recent quarters, investor fears about Canadian con-
will help to lower US oil imports from 10 million barrels/day in 2010 to about six million/day by 2035. As of the end of April 2013, US oil production stands at 7.3 million barrels/day which is up nearly 20% from a year ago.
Another drag on the Canadian stock market has been the sharp drop in agricultural and base metal prices. Commodity stocks represent almost 20% of the Canadian stock market while they are less than 1% of the US S&P 500.
Copper has earned the nickname of “Dr. Copper” for its reputed ability to call turning points in the economy. Oftentimes, copper Chart Source: prices have turned CAPP (Canadian Association of Petroleum Producers) www.capp.ca higher or lower in anticipation of the economy’s turning points. Copper sumer debt and elevated house prices have made prices have fallen by about 5% over the last two investors cautious on Canada’s banks. The fear years. A large part of the reason for the decline in arises from the distinct possibility that a decline in copper prices is likely due to fears about the ChiCanadian real estate will impact banks through risnese economy. ing mortgage defaults and a made-in-Canada debtreduction process. China’s leadership has made a central plank of its policies the intention to make the Chinese economy North American less reliant on construction and capital investment. The excessive reliance on construction and capital Economic Landscape investment has led to fears of a bubble in property When the Great Recession ended in 2009, one of and overinvestment in various industrial sectors. In the most repeated predictions was that the US savaddition, the European Union is the second largest ings rate would rise to match the levels of the 1960s consumer of copper and it is mired in recession and 1970s. The thought was that consumers had which has hindered copper demand further. Offundergone a generational change in mindset tosetting this weakness is the budding rebound in US wards spending and saving as a result of the ecoconstruction. nomic turmoil that had enveloped the global economy. After a brief rise in the immediate aftermath of
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tinue higher as central banks around the world are going to remain ultra-accommodative and help to ensure liquidity is well supplied to the markets. Though economic data has been disappointing in recent weeks, investor confidence is strong and the demand for equities has been resilient.
the Great Recession, the personal savings rate in the US has fallen once again to 2.3%. While this has helped the US economy achieve one of the best economic growth records amongst the advanced economies, the low savings rate is a function of poor wage growth. In fact, wages as a percent of the US economy are at a record low. Stagnant wage growth has helped to propel US corporate profits and they are now at a record level as a percentage of the US economy. As Ron Perelman, the chairman and CEO of Revlon stated recently in an interview: “Unfortunately what is good news for American industry...is bad news for those looking for work … We've rationalized our businesses over the last five years... those people that we laid off in 2008-2009, there's no need for us to hire back . . . We've gotten more efficient and we've gotten more productive." CEO of Revlon As the current economic recovery has been sub-par by historical standards, corporations have struggled to maintain revenue growth so they have been focusing on cost controls to help meet profit expectations. Corporate profit growth in the US was lower in 2012 than 2011 but the US market has been able to overcome slowing profits because investors have given the economy the benefit of the doubt. The Price-toEarnings (P/E) ratio has risen to about 16 – meaning investors are willing to pay $16 for each dollar of corporate profits. This has allowed the market to conPacifica Partners Inc. (Canadian Head Office)
Pacifica Partners featured in Zoomer Magazine
Pacifica Partners’ Chief Investment Officer, AJ Sull, was interviewed by Zoomer magazine in their March 2013 issue “Smart Money Strategies”. Excerpts from the interview available on our website at www.pacificapartners.com.
Pacifica Partners Capital Management Inc. (US branch)
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The information in this newsletter is current as at April 15, 2013, and does not Pacifica Partners Inc., Pacifica Partners Capital Management Inc. and/or their necessarily reflect subsequent market events and conditions. officers, directors, or representatives may hold some of the securities mentioned herein and may from time to time purchase and/or sell same on the stock market This newsletter is published for information purposes only and articles do not proor otherwise. vide individual financial, legal, tax or investment advice. Past performance is not indicative of future performance. No part of this publication may be reproduced without the expressed written consent of Pacifica Partners Inc. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance. The statements and statistics contained herein are Pacifica Partners Inc. is Canadian incorporated entity and is a registered Portfolio based on material believed to be reliable, but are not guaranteed to be accurate or Manager in certain Canadian Provinces. complete. Particular investments or trading strategies should be evaluated relative Pacifica Partners Capital Management Inc. is a US incorporated entity, wholly to each individual’s objectives in consultation with their legal, investment and/or tax owned by Pacifica Partners Inc., and a Registered Investment Advisor with the advisor. Pacifica Partners Inc. and Pacifica Partners Capital Management Inc. are SEC. not liable for any errors or omissions in the information or for any loss or damage © 2013 Pacifica Partners Inc. All rights reserved. suffered.
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