It’s the “right time” to look at the U.S.

Meanwhile, not only are the resources-heavy Canadian markets vulnerable to the effects of slower global growth, cyclical commodities producers are less likely to raise dividends because they don’t want to cut them later if profits fall.

As well, the timing for a plunge into U.S. equities is favourable, as the Canadian dollar (C$) has been riding a wave of strength for the past several years. As with retail goods, a strong loonie goes a lot further when purchasing U.S. stocks than the C$ did when it stood at considerably lower levels.

“Given the Canadian market’s strength in recent years and the rising dollar,” says Martin Cobb, lead portfolio manager of Templeton Global Smaller Companies Fund, sponsored by Toronto-based Franklin Templeton Investments Corp., “many Canadians are comfortable with the domestic names they know and have had little reason to look around. But I would turn that around and say those same circumstances make it exactly the right time to diversify outside the home country. Investors shouldn’t rest on their laurels.”

Undervalued, overlooked

Cobb has about 20% of the Templeton fund’s global assets under management in the U.S., his highest country weighting.

“The U.S. is the broadest and deepest market on the planet, and the choice of companies is beyond comparison,” Cobb says. “The unexciting performance of the past 10 years shouldn’t put investors off; it should encourage investors to look harder.”

Cobb’s view is based on Franklin Templeton research that shows no single geographical region, business sector or financial asset class will lead the way forever, and tomorrow’s winner is often today’s undervalued and overlooked territory. For the 10 years ended June 30, the S&P/TSX composite index turned in a 6.2% average annual return while the S&P 500 total return index, a U.S.-based broad index of stocks, gained a scant 1.2% in C$. The Canadian advantage, Cobb says, is unlikely to prevail during the next decade.

Stéphane Rochon, managing director and head of private client research at Toronto-based BMO Nesbitt Burns Inc., estimates roughly half of the Canadian market is made up of energy and materials stocks, while these resources comprise only 15% of the U.S. market. Surging demand for resources from emerging markets such as India and China had fired the performance of Canadian resources firms beginning around 2000, but the dwindling rate of growth in these regions has recently cooled this sector.

“Lower oil prices act as a tax cut for the U.S. economy and are creating a tailwind in an economy in which 70% of activity comes from domestic consumption,” Rochon says. “We are also bullish on a recovery for U.S. housing, which is in the early stages of an upward inflection point. Prices are flat or rising in 80% of U.S. markets.”

And although the Canadian banks also are a major contributor to the market capitalization of the Toronto Stock Exchange (TSX), Rochon says, this sector has no undiscovered bargains. In addition, Canadian banks could be vulnerable to a pullback if there is any contagion from a banking crisis in Europe, or if the hot real estate market in Canada gets hit by a correction.

“We have been recommending that our clients increase their U.S. exposure,” Rochon says. “But we stress that we are looking at a multi-year time line and are not trying to day-trade. We like the U.S. for investors with a time horizon of two to five years.”

Superior potential

Rochon is most bullish on opportunities in the U.S. technology, health care, consumer discretionary and industrial sectors. The Canadian market offers considerably less choice in these areas.

At Toronto-based CI Investments Inc., Eric Bushell, vice president and chief investment officer of CI’s Signature Global Advisors division, shares a similar perspective on the superior potential of the U.S. He particularly likes technology, health care and multinational firms.

The financial crisis of 2008 had resulted in a “shock” that forced U.S. companies to cut costs and restore their balance sheets, Bushell says, and they are now in fighting form. As profits and cash flow increase, U.S. firms will be in a position to raise dividends as well as buy back stock, a strategy for increasing value per share.

“There is growing recognition that the Canadian market is poor in diversity, liquidity and quality of issuers,” Bushell told the recent Morningstar Canada Investment Conference in Toronto. “There are few large, globally competitive Canadian companies anymore as a result of the numerous takeovers of the past decade or so. Investors are rightly questioning the relevance of the TSX as a benchmark.”

Bushell believes that big multinational firms, with their economies of scale and access to capital, will become more dominant and take market share in a slower- growth environment, leading to increased profitability and rising share values.

© 2012 Investment Executive. All rights reserved.