Canadian bull looking tired

It usually comes as no surprise when a global money manager suggests investors trim their Canadian equity exposure and invest their profits offshore. But when a Canadian equity fund manager expresses concern about the health of the current bull-run, investors may want to pay attention.

“The Canadian equity market as we all know has been tremendous, but sources of return have been fairly concentrated,” said Fred Pynn, co-lead manager of the Bissett Canadian Equity Fund, speaking at the annual Franklin Templeton Investments Outlook and Opportunities Forum in Toronto.

At the advisor-only session, he reminded the audience that the Canadian rally has been fuelled almost entirely by the energy, materials and financial sectors.

“It’s been a great place to invest, but now we’re starting to get a little nervous, given how long and strong this bull market has been and the speculative activity which is being layered on top of all of this,” he said.

Of course, it makes sense for energy to climb, as the price of crude now appears comfortable above $70 a barrel. And the massive global economic expansion has driven metals prices so high that thieves steal transport trailers not for their content, but to sell as scrap. The capital generated in energy and mining needs a home, so it is logical that the financials would benefit.

“There’s a reason the stock market has done well — it’s directly correlated with the improvement of corporate profits since the last recession,” Pynn said.

But the length and strength of the current commodities cycle has now outstripped that of the late 1980s, just before the market reverted to its long-term mean.

While Pynn is not predicting these sectors will collapse any time soon, he does express concern over the return of speculation in the market, as short-term buyers try to guess the next target for mergers and acquisitions.

Corporate earnings continue to grow, but he points out that the 2006 growth rate of 16% is below the historical rate of 20%. The rate of growth is expected to slow further for full-year 2007 and 2008, but remain in the double digit range.

Pynn is not recommending that investors sell off their entire Canadian portfolio, of course, but he suggests that higher quality stocks may be preferable, as they will outperform in a slower market.

Dividend paying stocks underperformed non-dividend paying stocks in 2006, but that result was atypical of the longer term track record. Compounded dividends make up a larger part of overall long-term market returns, and companies that have a track record of raising their dividends tend to maintain that habit.

At the same time, investors should probably shift assets into cheaper sectors of the market — the first half of the whole “buy low, sell high” concept.

On the topic of selling high, the soaring Canadian dollar — which topped 95 cents U.S. this week — has made investing outside of Canada cheaper than ever. When the loonie eventually reverts to the mean and moves lower, foreign investments will benefit.

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“In some respects, the value of the Canadian dollar is self-reinforcing,” he said. While Canadian-denominated investments in the U.S. have been disappointing, American investors dabbling in our market have seen their returns juiced by currency fluctuations.

“The domestic economy is strong, and this is evidenced by how attractive Canada looks to foreigners,” he said. “We are the only G7 country to have both a current account surplus and a budget surplus.”

But he points out that these developments — the commodity rally, the soaring loonie — are in the past, and that investors need to recognize that no market is immune to an eventual downturn.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(07/26/07)

Steven Lamb