Canada has found itself in a relatively favorable economic
position in the post-recession environment. The country is on a
solid fiscal footing, has a low debt level, and its primary trading
partner—the U.S. is back on track.
This has allowed the country to avoid the a European infection
of its economic growth story, helping Canada to bounce back
relatively well from the crisis. It also hasn’t hurt that the
country’s banks were much more conservative, so there was much less
of a hole to dig out of to begin with anyway.
Despite this, the country’s stock markets have underperformed
their American counterparts, at least from an ETF look in YTD
terms. The country’s most popular ETF, the iShares MSCI
Canada Index Fund (EWC) has added just under 4.4% so far
in 2012 compared to a nearly 15.8% gain for the S&P 500 in the
same time period (read Generate Alpha with these
Outperforming ETFs).
This is somewhat surprising, as for the most part, EWC and
SPY have an extremely high correlation with each
other, pretty much moving in lockstep. Seemingly the only
difference—besides the divergent returns—has been a greater
volatility level for EWC.
Admittedly, this is a disappointing result for the Canada ETF as
the country should have been a big beneficiary of the rebounding
American economy. Plus, a floor under many commodity prices could
have also been a catalyst for strength in the Canadian stock market
this year.
While this was certainly not the case in the beginning of the
year, it appears as though these factors are finally trickling down
into stock prices as we close out 2012. In fact, over the past six
months the highly correlated SPY and EWC are now showing that EWC
is the better performer, edging out its American counterpart by
several percentage points in the time frame in question (see The
Five Best ETFs over the Past Five Years).
This could suggest that the sentiment is finally starting to
turn on the overlooked Canadian market, and that now might be the
time to consider a play on America’s neighbor to the north in ETF
form, as EWC currently receives a Top Zacks ETF Rank of 1 or
‘Strong Buy’. This could be particularly true if two vital sectors
for the Canadian stock market continue to hold up; financials and
commodities.
Although the Canadian economy is pretty well diversified, EWC
and the broader Canadian stock market are relatively concentrated
in a few key sectors. Financials (32%), energy (26%), and basic
materials (19%), account for the lion’s share of assets in EWC,
leaving a paltry amount for the rest.
Furthermore, among the top ten individual securities, financials
take up four of the top five spots, while only one company outside
of the three sectors listed above makes its way into the top ten.
This is despite the fact that the ETF holds over 100 securities,
showcasing just how concentrated in these few segments this ETF is
(Canada Equity ETFs Worth a Look).
As a result, these sectors look to play an outsized role in
Canada’s stock recovery heading into 2013. There is somewhat of a
high bar for this as well, as the yield is pretty much the same for
this fund as the S&P 500, although EWC costs 52 basis points a
year, a far greater level than what ultra-low cost S&P 500 ETFs
charge investors currently.
With this price differential and high correlation to the
American market, it could be tough to outperform but not
impossible. A few things will definitely have to happen though for
EWC to continue its winning streak against SPY:
First, commodity prices must remain stable, or even better,
rise. Oil is a key product for the country and thanks to fracking
technologies, could be even more so as the years go by (see Top
Commodity ETFs in This Uncertain Market).
Beyond oil, the country is also a big producer of agricultural
commodities as well, so these will have to stay strong heading into
2013. Base and industrial metals are also key, and these can be
volatile so it could be a rocky road in this corner.
Either way, it is hard to imagine continued outperformance
without another strong showing from the Canadian financial sector.
As we touched upon earlier, the space has done better than most,
but some concerns are starting to appear (read Active Large Cap
ETFs: The Best of Both Worlds?).
Worries over a property bubble are spreading in some parts of
the country, which could be damaging to bank credibility across the
nation. In particular, prices are being bid up in Vancouver on
strong Asian demand while a similar situation is happening in
Toronto.
Resource-oriented cities could also be experiencing a bit of a
boom, while some of the recent housing data hasn’t exactly been
favorable. Should a bubble burst in Canada, the financial sector
could be taken for a ride and end the short-term outperformance of
Canada against the U.S.
Our view is that Canada has not overheated and that its robust
financial position overall, combined with its in-demand
commodities, will power it through in the short term. While there
are definitely some pressing issues in regard to the housing mess,
we think that Canada could be an interesting relatively short-term
play for investors seeking to make an equity play as we close out
the year and head into 2013.
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ISHARS-CANADA (EWC): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
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