Investment strategies in a sluggish economy

Daniel Bubis, president and CEO of Winnipeg-based Tetrem Capital Management Ltd. Bubis and his team manage a range of mutual funds for CI Investments Inc., including CI Canadian Investment and CI Canadian Investment Corporate Class.

Michael O’Brien, managing director and head of the core Canadian equity team at TD Asset Management Inc. His mandates include that of lead manager of TD Canadian Equity, TD Canadian Blue Chip Equity and TD Balanced Income.

Mark Thomson, chairman of the board and managing director, equities, at Beutel, Goodman & Co. Ltd. Thomson and his team are responsible for a range of mandates including Beutel Goodman Canadian Equity, Beutel Goodman Canadian Dividend and Beutel Goodman Balanced.

Ian Hardacre, vice-president and head of Canadian equities at Trimark Investments, a division of Toronto-based Invesco Canada Ltd. His mandates include the flagship Trimark Canadian.

The roundtable was convened and moderated by Morningstar columnist Sonita Horvitch. Her three-part series continues on Wednesday and Friday.

Q: What challenges does the Canadian economy face?

Bubis: It is going through a pretty sluggish period. The Canadian dollar is weak relative to the U.S. dollar, partly due to the weakness in the oil price. But bigger picture, the U.S. dollar has strengthened against virtually every other currency. It’s a global phenomenon. The oil price matters to Canada and to the Canadian equity market. The impact of a weaker oil price on the economy fades as you go from west to east, but it’s still there. The benefit of a weaker Canadian dollar on Canadian exports is not what it used to be. We don’t have the same manufacturing and export-driven base.

Thomson: We’re in a low-growth global economic environment and Canada is a participant in that. This global low growth is good for capital markets. There’s nothing to choke off liquidity at this point and liquidity ultimately drives financial markets.

O’Brien: We were in a long federal election campaign and some people played up the idea of Canada in a technical recession. I’m not that downbeat about the Canadian economy. I agree with Mark that we’re in a slow-growth environment globally. How is Canada going to get through this? Alberta is dealing with its economic challenges. But with the low Canadian dollar and given that 75% of our exports go to the United States, where the economy is firmer, the Canadian economy is going to be all right. Globally, this summer, the concern shifted from Europe to emerging markets, particularly China. That does adversely impact some important sectors in the Canadian equity market.

Hardacre: Energy represents some 19% of the S&P/TSX Composite Index. I think there’s a lot of upside from here on, because energy has reset so much. This is the opportunity. With commodity prices, in general, at these low levels, our view is that there is upside from here. Timing is an issue.

Q: How will the new majority federal Liberal government impact the Canadian economy and financial markets?

Thomson: The last regime was interventionist. The extent to which the new regime is interventionist will determine how things work out. The Conservatives had certain industries, outside of energy, that they were targeting in a negative way. To the degree that this is diminished under the new regime, it will be good for Canada.

Q: One of their targets was the telecommunications-services sector.

Bubis: The Conservatives were very populist in a lot of ways.

Thomson: They stopped foreign takeovers, in some instances.

Bubis: From a financial-market perspective, we probably got the best outcome from the federal election that could reasonably be expected. Coming into the election, it was clear that the Conservatives were unlikely to win a majority. In the summer, the likely outcome seemed to be a minority government, maybe a minority Liberal government that might consider partnering with the NDP. The outcome gives Canada a chance to move on.

Hardacre: The importance to the Canadian equity market of global matters cannot be overlooked. Looking at Justin Trudeau’s campaign, there were few policies that will likely impact the larger sector weights in the Composite. There are proposed increases in certain personal taxes at the margin, which might affect people’s ability to invest. What happens in China and the rest of the world is most important and beyond the control of any Canadian government.

O’Brien: From an international investor perspective, the outcome of the election is likely to be relatively comforting. Outside Canada, people view the Liberals as the other federal party. An NDP government in Ottawa would be more of an unknown. One area in the campaign where the Liberals did have a significant difference in economic policy was their desire to spend more on infrastructure: fiscal stimulus at the expense of balancing the budget. Also, what could potentially have an impact on the energy and power sectors is the federal Liberals’ environmental policy.

Q: There is also the uncertainty about the environmental policy of the NDP government in Alberta.

O’Brien: Maybe a Conservative federal government could never engender the belief that it would put a credible environmental policy in place. Maybe there has to be an NDP government in Alberta and a federal Liberal government to have the credibility to respond to environmental concerns. But it is important not to strangle the golden goose. This environmental issue is not going away and the governments and the industry must deal with it.

Q: Canada’s S&P/TSX Composite Index has underperformed the S&P 500 Index and the MSCI World Index over the nine months to the end of September and over one year, three years and five years to the end of September. This underperformance was more marked when all three indexes were expressed in Canadian-dollar terms.

O’Brien: In the first nine months of 2015, in local currency terms the Composite had a negative total return of 7%, while the S&P 500 Index had a negative total return of 5.3% and the MSCI World Index had a negative total return of 5.6%. But the Composite more dramatically underperformed in Canadian-dollar terms in the first nine months of 2015. There is similar underperformance in Canadian dollar terms if you look at one, two, three years, five years.

Bubis: Canada’s underperformance began after 2011 and continued into 2012, 2013, 2014, and in the first nine months of 2015. The Canadian dollar peaked against the U.S. dollar after 2011.

Thomson: Remember that the S&P 500 Index was flat for over a decade, while the Canadian equity market was doing extremely well on the back of the commodity cycle. Commodities are under pressure now, so there is a reversion to the mean.

O’Brien: Look at the composition of the S&P/TSX Composite Index and the importance of the commodity sectors and the connection to global growth. In 2011-2012, people began to feel that China’s growth was slowing and, at the same time, you had massive stimulus programs in the United States, Europe and Japan. Global money flowed into those areas. Canada was lumped in with the emerging markets and other markets considered undesirable.

Q: In the 12 months to the end of September, the Composite had a negative total return of 8.4%, with the four biggest sectors producing negative total returns. Energy (18.5% of the Composite) produced a negative 34% total return. Materials (9% of the index) had a negative total return of 29.3%. Industrials (8.3%) produced a negative total return of 10.4%. Financial services (37% of the index and by far the biggest sector) had a negative total return of 1.5%. Why were the Canadian banks, which are big weights in the financial services sector, weak?

Thomson: The U.S. shorts have been driving down the Canadian banks from an ill-informed perspective, from anything that I have seen. The Canadian financial analysts, who have little appreciation of how great the Canadian banking industry is, were largely in concert with American shorts, even though the Canadian analysts should have known better. This provides a great opportunity. Canadian bank stocks have moved up sharply off their lows on Aug. 24, but they are still really cheap.

Hardacre: There are a lot of U.S. investors who are bearish on the Canadian banks, because of Canada’s real-estate cycle. International investors don’t appreciate the fact that the Canadian banking system is different from many banking systems in other developed countries. It’s an oligopoly. Even though there are some drags on the banks, right now, this is on the margin. This might slow their earnings growth a little, but it doesn’t impact their strong franchises.

Bubis: There is a short-Canada thesis because of the energy market and the concerns about Canadian real estate.

O’Brien: Canada is out of favour among international investors. Furthermore, if you read our mutual-fund data, funds are coming out of Canadian equities and going into foreign equities. To Danny’s point about the short-Canada thesis, if you’re large global investor and you want to short Canada, bank stocks are liquid and easy to get in and out of.

Part one of a three-part Canadian equity roundtable.

The three-part series continues on Wednesday and Friday.