October 24, 2014

Canadian Economy Explained

 

For those of you who have only recently become interested in the Canadian economy there are a few main principles that shape the investing landscape of the Great White North.  The most recent economic revelation for Canada has been our stability relative to the rest of the world.  Our balance between a capitalistic, trade-heavy market and a well-regulated banking sector allowed Canada to weather the 2008 recession much better than its G8 brethren (Canada’s debt is the lowest of the G8 countries).  Canada relies on this strong banking sector, our huge cache of various natural resources, and our bevy of international trading relations in order to fuel an extremely high standard of living for Canadians across the country.

 

The Toronto Stock Exchange (TSX) is the nation’s main market to buy and sell stocks in many companies.  Its main index is called the TSX 60.  The TSX 60 is basically the Canadian version of the Dow Jones Industrial Index.  Whereas the Dow is comprised of only 30 stocks, the TSX 60 is comprised of the 60 biggest stocks on the TSX.  Its holdings give exposure to about 75% of the total capitalization of the entire TSX.

 

The first thing you will immediately notice upon examining the TSX is the heavy reliance Canada has on energy and materials.  Roughly half of the stocks listed on the TSX are from those sectors, and Canada lists more of these companies in materials and energy than any other stock exchange in the world.  Many people are not aware that Canada sits on top of the second largest oil reserves in the world (Saudi Arabia) or that we are a top supplier of Potash and Uranium (just to use two diverse examples).  Generally, Canada’s economy and economic indicators move up and down with the price of commodities around the global market.  The natural result of being a commodity and resource-driven economy is that Canada depends largely on international trade.  In fact, although Canada ranked 35th in the world in population in 2011, it was ranked 9th in the world for total goods traded according to the CIA fact book.

 

Other than energy and materials, the vast majority of the TSX 60 are companies in the fields of finance, utilities, telecommunications, and railroads.  The reason most of these companies are so stable (and consequently perfect for dividend watchers, and investors looking for income as opposed to growth opportunity) is that Canadian industries are generally oligopolies.  This means that they are controlled by a few major players.  Because you are really only talking about a population roughly the size of California, or the Eastern Seaboard, 2-6 main companies in each field usually are about all the service market can handle.  This low-level of competition makes them very appealing to investors.  For more information take a look at the banking and telecommunications industries that account for 30% and 6% of the TSX respectively.

 

Recently our economy has been suffering the consequences of success.  If this seems oxymoronic to you, I admit that it is counterintuitive.  The main reason this has occurred is because the commodities sector has had such a great run, and our banking sector is now looked upon as the world model of stability, investors have been pouring into our markets.  This means that our dollar has climbed to its highest sustained value in recent memory.  Although this has been a boon to Canadian consumers (and American cities close to the Canadian border), it is playing havoc with our trade-dependent economy.  The manufacturing sector in relatively densely populated parts of the country has been hit especially hard, as the trade balance is not in their favour.

 

In terms of the medium- and long-term outlook for the Canadian economy, I believe it is a pretty strong investment opportunity.  With a growing demand for commodities across many sectors thanks to the industrialization of massive emerging markets like Brazil, India, and China (not to mention the consumer monster that we have always fed in the USA) Canadian natural resource companies will see record profits in the years to come.  Because they are backed by such a stable banking sector, a successful democratic government, and an advantageous geographical position, it makes these companies all the more lucrative to investors.  This is especially true when you compare them to the relative instability of many resource rich countries around the world (see: Oil, Middle East).

 

If you’re looking for a quick and easy way to invest in the Canadian economy as a whole there are some excellent ETF options out there that do a good job of mirroring the TSX as a whole.  They also offer the very competitive fees that are making mutual fund advisors so jealous.  The most popular is probably the iShares CDN LargeCap 60 Index.  It simply tracks the TSX 60 for a negligible fee.  The Claymore S&P/TSX Cdn Dividend tracks the Canadian Dividend Aristocrats Index and is another excellent choice.  Two other options are the Horizons AlphaPro Managed TSX 60 (more of a mutual fund/ETF hybrid), and the Claymore Canadian Fundamental Index.  All Canadian ETFs have holdings that are heavy in energy, materials, and financials due to the fact they make up such a large part of the Canadian market.

 

 

 

Canadian Stock Market Explained


 

Since Canada has emerged from the recent global economic downturn relatively unscathed, many investors have been looking into the Canadian stock market.  All it takes is one peak at the TSX 60 (the Canadian equivalent of the Dow Jones Industrial Index) to realize that the Canadian stock market is heavily dependant on energy & materials, as well as their all-star banking sector.  In fact, at any given time energy and materials likely make up nearly half of the total capitalization of the Toronto Stock Exchange (TSX), while financials hold about 30% of the market.  Telecoms, utilities, railroads, and consumer discretionary/staples make up the rest.  Commodity prices generally drive the larger economy, and the TSX is known for listing the most energy stocks of any stock exchange in the world.  Keep this in mind if you are looking into broad-scale exposure regarding the Canadian market as it will be overweight in energy, materials, and financials by definition.

 

Income Trusts and REITS

 

One defining aspect of the Canadian Stock market has been its extensive range of income trusts and income funds available.  For those of you that are not familiar with these financial vehicles, they are essentially funds that were set up to provide investors with large rates of return in a tax advantageous situation.  Many of these trusts did this by using a return of capital format that dodged the double taxation that occurs when a business pays business taxes and then its shareholders have to pay dividend taxes as well.  In January of this year, new taxation rules on income trusts put a stop to this tax-avoidance structure with the exception of Real Estate Investment Trusts (REITs).  These funds hold real estate in trust and are required to pay out a certain percentage (usually 90%) of their income in the form of distributions to their shareholders each year.  Index funds and index trusts were very popular with investors looking for income from their investments, especially in times when the bond markets were down.

 

ETFs

 

Rather than try to pick certain stocks and use a labour-intensive means of trying to get broad exposure to Canadian stock market, many investors are choosing to simply pick one of the efficient ETF options that are offered.  Their low fees are very attractive, and their trade volumes mean that they are a very liquid asset.  The most popular is probably the iShares CDN LargeCap 60 Index.  It simply tracks the TSX 60 for a negligible fee.  The Claymore S&P/TSX Cdn Dividend tracks the Canadian Dividend Aristocrats Index and is another excellent choice.  Two other options are the Horizons AlphaPro Managed TSX 60 (more of a mutual fund/ETF hybrid), and the Claymore Canadian Fundamental Index.  All Canadian ETFs have holdings that are heavy in energy, materials, and financials due to the fact they make up such a large part of the Canadian market.

 

High Mutual Fund Fees

One reason why ETFs have been so popular in the Canadian market is because of the prohibitively high fees that Canadians pay on mutual funds.  Management fees of over 2.5% are not uncommon, and they are commonly ranked as the most expensive in the world.  Plainly the utility and efficiency advantages of exchange traded funds would be very appealing in this environment.

 

Canada’s stock market could be considered volatile in some areas due to the extremely heavy reliance on three main sectors (two if you consider materials and energy to be one-and-the-same).  The TSX does tend to move up and down with the price of commodities such as Uranium, Copper, Nickel, Gold, and especially oil.  On the other hand, Canada offers a stable geographical position in the world, a government system with a long track record of overall responsibility, a well regulated and efficient banking system, and a relatively well educated population that gives our investment options solid backing.