The Canadian economy is dominated by Financials and has a diverse and abundant exposure to natural resources. Despite the close proximity, the composition of the country’s stock market couldn’t be more different from that of the US.
They have a much higher relative exposure to areas like Financials, Energy, and Materials… Basically, all the things that are working.
On the other hand, they have significantly lower exposure to areas like Technology, Health Care, and Discretionary… Basically, all the areas that are NOT currently working.
Long story short, considering the current backdrop of global economic growth and reflation, rising rates and commodity prices, and rotation into cyclical areas and value stocks… the environment is as ripe as ever for Canadian Equities.
In this post, we’ll discuss the emerging strength we’re seeing from Canada and outline a variety of ideas to take advantage of it.
First, take a look at the sector breakdown for Canada’s TSX Capped Composite Index to understand what’s driving its performance.
This is a value investor’s dream! Almost 70% of the index is comprised of economically-sensitive sectors. Not to mention, over a whopping 30% is in Financials alone… while only 10% is in Tech.
In fact, the market’s old secular leaders – Tech, Communications, Health Care, and Discretionary, only make up about 20% in total. Fortunately for Canada, these growth sectors have fallen out of favor, and the country is perfectly positioned to benefit from the new leadership regime.
Let’s contrast the index’s composition with that of the US now.
The old leadership sectors represent a commanding 60% of the S&P 500. Meanwhile, Materials and Energy only make up a measly 2-3% each, vs 12% and 13% respectively, for Canada.
And at 14% Financials don’t even account for half the weighting in the S&P as they do in Canada. Instead, the US is dominated by Tech with an almost 25% weighting.
For these reasons, it’s no surprise the MSCI Canada ETF $EWC has nearly doubled the performance of the S&P 500 $SPY since last fall.
This outperformance started right around the same time key relative trends like Growth vs Value, Us vs World, and Large vs Small began to accelerate to the downside. This isn’t a coincidence.
In fact, here’s an exercise… Does this chart pattern in US vs Canadian stocks look familiar?
It’s almost identical to Growth $IWF vs Value $IWD, right?
Both are currently flirting with their early 2000 highs, but there’s one substantial difference… Unlike IWF/IWD, the US vs Canada ratio is still holding onto this key level just above 11… for now, at least.
After a decade of US outperformance, this is as logical a place as any for this relative trend to reverse in favor of Canada.
Considering the recent weakness, we think it’s only a matter of time before this happens. Here’s a closer look.
The ratio just closed out the week at its lowest level since this time last year.
If this topping pattern is valid – which it sure seems to be, we’re anticipating downside follow-through and a violation of those key 2001 highs in the coming weeks.
This is yet another piece of evidence that suggests we’re heading into a very different environment than we’ve been used to. One where the US is no longer global leadership.
As such, we’re looking for the new world leaders, and all signs indicate Canada is going to be one of them.
Here’s the iShares MSCI Canada ETF $EWC.
We like this vehicle as a way for US investors to express a bullish thesis on Canadian equities.
Our risk is very clearly defined at the 2014 highs of 33. As long as we’re above this level we want to own EWC with a target of 42 over the next 3-6 months.
Here’s a longer-term look.
Price just broke above its downtrend line from the pre-financial crisis peak as it continues to work on resolving higher from a nearly 14-year base.
So not only are Canadian stocks working on a potential long-term relative trend reversal, but they’re also breaking out of a massive base on absolute terms.
After making no progress for almost a decade and a half, it looks like things could just be getting started.
When we remove the impact of the US Dollar, Canadian equities are already at all-time highs in their local currency.
This is the iShares S&P TSX Capped Composite Index $XIC, which is listed on the Toronto Stock Exchange. Think of it as Canada’s equivalent to $SPY here in the US.
We want to own XIC as long as we’re above 28.70 with a target at 35 over the next 2-4 months.
Now let’s dive into some of our favorite Canadian stocks.
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