May Market Review
US stocks continue to outpace Canadian issues
Strong US market performance during the past month and the year so far, have more than compensated for the weakness in Canadian stocks, which had a rough April. In this month’s market review, we will take a closer look at the relationship between US and Canadian stocks.
The performance of US stocks is particularly important for Canadian individual, institutional and pension fund investors, which tend to have well-diversified portfolios that include significant US holdings. This, plus the interconnectedness of the Canadian and US economies and the shear size of the US markets mean that developments there are followed by almost all market watchers.
Canada is a trading nation, which exports a far higher percentage of its production than most countries. The vast majority of those exports go to the United States. That means tracking US economic developments closely, provides an excellent advanced signal regarding demand for Canadian products and thus of exporters profit levels.
The shear size of US capital markets and their corresponding influence on world events is another reason that Canadian investors track developments there. The US generally accounts for between 20-25 percent of global GDP growth (depending on whether this is calculated in terms of purchasing power parity, or in currency terms). However American stocks account for almost half of global capital markets.
This is due in large part to the relative weakness of competitor markets. European stocks trade on three different exchanges (London, Paris and Frankfurt). The London and Tokyo markets are too small. And China’s remains far too closed to provide a real investment alternative. So the US is the de facto “go-to” place for international money flows. The size of US bond markets played out in spades during recent uncertain times when international investors continued to increasingly move cash there, despite low yields, due to their relative security.
Ironically the Canadian S&P/TSX has generally tracked the US Dow Jones Industrial average closely in local dollar terms (when currency swings are left out) over the past few decades. This is in large part due to the two countries’ similar economic profiles. Per capita GDP in both nations is relatively similar, with the US economy about ten times larger than Canada’s. Growth rates in both countries both have tended to run between 2.0 and 3.0 percent during many stretches of the past two decades. As if that were not enough, Canada’s monetary policy generally closely tracks US Federal reserve actions.
True, Canada’s economy outperformed its southern neighbor in the aftermath of the 2007-2008 financial crisis and the ensuring recession. However during 2011, 2012 and so far this year, US stocks have been playing “catch up,” with the Dow Jones Industrial Average now well ahead of the S&P/TSX. Lower demand for Canadian raw materials, sparked by a slower growth outlook in China and other emerging economies has been also playing a role, as is a bottleneck in getting Canadian oil to world markets.
If there is a lesson to be drawn from the small differences in Canadian and US stock performances over the years, it relates the importance of diversification. Because while local investors who held a balanced portion of US equities thus have done quite well so far this year, at some point it will be Canadian stocks’ turn to pick up the mantle.
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Peter Diekmeyer Communications Inc.