Investors in the U.S. are looking forward to their Independence Day holiday on July 4, but every year, Canadians get a jump on their southern neighbors by celebrating Canada Day on July 1. In honor of Canada’s national day, let’s take a look northward to learn more about the Canadian stock market and which of its prospects deserve a closer look from U.S. investors.
One reason looking at Canada today makes sense is that for value investors, the market’s lagging performance shows that Canadian stocks are out of favor right now. The iShares MSCI Canada ETF is down 7% so far this year, compared to about a 13% gain for the U.S. S&P 500.
When you look more closely at the mix of stocks that make up the Canadian market, the explanation for the nation’s underperformance gets clearer. Energy and materials make up almost 40% of the MSCI Canada index, with financial stocks coming in at more than 35%. With those two areas dominating Canadian stocks, how those sectors perform largely defines how the overall market does.
Lately, those sectors haven’t done all that well. Terrible performance in the commodities markets have really hurt Canada’s natural resources industry, with dozens of companies suffering from the decline in precious metals like gold and silver so far this year. Vancouver-based Goldcorp Inc. (USA) (NYSE:GG) and Toronto’s Barrick Gold Corporation (USA) (NYSE:ABX) rank among the biggest gold producers in the world and have big advantages in cost and economies of scale over some of their smaller rivals. Yet the plunge in gold prices has hammered their share prices, casting a shadow over the overall Canadian market’s performance.
Energy has also held the Canadian economy back, with challenges hampering the potential growth in the industry. Enbridge Inc (USA) (NYSE:ENB) and TransCanada Corporation (USA) (NYSE:TRP), for instance, both have huge opportunities to capitalize on prospective new pipelines, yet environmental concerns haven’t allowed the companies to work as quickly as they might otherwise to build out energy-transportation infrastructure for hard-to-reach production areas.
Canada’s fear of financials
Given the challenges for natural-resource stocks, Canada’s underperformance on that front isn’t surprising. But even though Canada’s banks have long been regarded as being much healthier than their U.S. counterparts, economic conditions are catching up with the financial industry north of the border.
It’s true that Canada’s banking giants face tough regulation compared to their U.S. counterparts. That, combined with differences in the way that Canadians finance major expenses like home purchases, helped shelter Canada from the full brunt of the financial crisis in 2008. But lately, Canada’s banks have had more leverage than their U.S. counterparts, and credit-rating agencies have downgraded prospects for Toronto-Dominion Bank (USA) (NYSE:TD) and other big Canadian financial institutions. Moreover, levels of consumer credit in Canada have risen to extremely high levels even as American consumers reduce their outstanding debt levels in many areas, and housing prices have raised concerns of a potential real-estate-led contraction at some point in the future. As a result, Toronto-Dominion is down 3% so far this year, with most other banks following suit with similar modest declines.