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The Canadian Equity Markets: An Overview

Fuelled by its wealth of natural resources in the energy and mining sectors, Canada has been among the best performing equity markets over the past decade

Rudy Luukko 6 December, 2011 | 8:54AM

Fuelled by its wealth of natural resources in the energy and mining sectors, Canada has been among the best performing equity markets over the past decade.

But this affluent northern nation has struggled lately, amid slumping commodity prices and the general global economic woes. Even so, Canada has a lot going for it--in terms of financial and political stability--and should be more resilient than most countries if the downturn continues.

Through the first 10 months of this year, the S&P/TSX Composite Total Return Index, a broad market-weighted measure of the performance of stocks listed on the Toronto Stock Exchange, lost 6.8% in U.S.-dollar terms. That compares unfavourably with a more modest 2.7% loss for the MSCI World Index, and the 1.3% total return of the S&P 500 Index of Canada's southern neighbour.

The hardest hit Canadian sectors included energy, in response to plunging crude-oil prices. Among the biggest and most widely held stocks that sustained double-digit losses were Suncor Inc. (SU), a major player in Canada's massive oil sands in northern Alberta, and Canadian Natural Resources Ltd. (CNQ), which is active in oil and gas exploration and production in Western Canada, the North Sea and the West African offshore.

Also dragging down the overall returns of the Canadian market was Canada's relatively small information-technology sector. This was primarily stock-specific; the sector's main component is the beleaguered Blackberry maker Research in Motion Ltd. (RIM). In Canadian-dollar terms, RIM shares have nosedived 65% in response to deteriorating earnings and its eroding market share in smartphones.

The recent pullback in the Canadian stock market follows a long period during which it had been among the best performers in the developed world. In the past 10 years, the S&P/TSX Composite has produced a robust 13.7% total return in U.S. dollar terms, while the MSCI World Index (including reinvested dividends) has returned only 5.1%.

Generally speaking among the world's main economic blocs, only the emerging markets--as can be seen with the 17.2% annualised 10-year return of the MSCI Emerging Markets Index--have outshone Canada.

Though it sprawls over nearly 10 million square kilometres, second only to Russia in total area, Canada is the smallest of the G-7 countries in terms of its population of 34.1 million and its roughly US$1.6 trillion GDP.

In terms of per-capital GDP, however, Canada's population punches above its weight. Currently, the Organization for Economic Co-operation and Development (OECD) ranks Canada ninth in the world in per-capita GDP, as measured in constant prices (base year 2005) and purchasing-power parity.

The purchasing power of the Canadian dollar, despite having dipped in recent months, has more than held its own in recent years. Since late 2008, it has appreciated sharply versus the U.S. dollar, the euro and the British pound.

In contrast to soaring yields in European sovereign debt that have saddled bondholders with capital losses, the Canadian government's debt obligations carry a triple-A credit rating that has enabled yields to remain fairly stable. Currently, 10-year Government of Canada bonds yield just over 2%.

Apart from the high degree of creditworthiness of Canada that is the envy of most countries, there is a lack of enthusiasm these days on the part of investors in the Canadian fixed-income markets. This is due to the lack of real returns after inflation.

Canada's national inflation rate, as measured by the Consumer Price Index compiled by the government agency Statistics Canada, is currently running at an annualised rate of 2.9% as of the end of October. This exceeds the 2% target rate over time of the Bank of Canada, the country's central bank, for which keeping a lid on inflation is a top priority.

Canada's inflation rate far exceeds the interest yields currently being paid on cash and fixed-income instruments, particularly those at the short end of the maturity curve. This has left investors caught between a rock and a hard place. They find themselves having to choose between volatile equity markets on one hand, and minuscule cash and fixed-income returns on the other.

Under these market conditions, two types of investment-fund products have been gaining market share in Canada's retail marketplace.

One is exchange-traded funds, whose dominant player is BlackRock with its iShares family and whose new entrants include global giants PowerShares and--most recently--Vanguard. Low fees hold increasing appeal during times like now, when returns are scarce and management-expense ratios become all the more visible.

Meanwhile, in the still much larger market for traditional open-ended mutual funds, the product of choice in Canada is balanced funds, whether in the form of stand-along mutual funds, fund-of-fund portfolios, asset-allocation programmes or target-date funds. These provide a refuge, of sorts, for investors who are increasingly disillusioned with the evident risks but uncertain rewards of equity investing.

These same investors also realise that they can also lose out by "playing it safe" and shunning equities. In the current low-yield environment, Canadian investors who hold only cash and fixed-income instruments are virtually guaranteed to lose purchasing power due to inflation and taxes.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Rudy Luukko