First is the worst, second is the best. That old schoolyard rhyme is particularly true for Canada.
That’s because we tend to underperform in the first half, or recovery part, of an economic cycle. But we outperform in the second half, or expansion portion, says David Taylor, president and CIO of Taylor Asset Management in Toronto.
That’s when “factories are full, and they start to spend real capex; they start reinvesting in the business,” says Taylor, who manages the top-performing fund in the focused Canadian equity category year-to-date. “Historically, when you get to that point, Canada starts to outperform the U.S.”
He points to strong auto sales, housing starts and loan growth as leading indicators.
Taylor has been bullish on Canada since the beginning of 2016. He was 50-50 Canada-U.S. in February, and went to 75-25 Canada-U.S. after that. “Our equity fund is pushing 40% [return],” he says, as the U.S. market is up 9%. Even Taylor’s U.S. allocation is “Canadian-like,” meaning that it’s primarily cyclical stocks.
His move paid off, but at the time it was “highly contrarian,” he admits. “I didn’t sleep for a month.” He looked at valuations and put himself in the shoes of both U.S. and Canadian investors. “If I were an American and I woke up with my strong U.S. dollar and a weak Canadian dollar looking for stocks, I’d look north of the border,” he says. “Not only could you buy stocks cheap, but you could also buy them at a 40% currency discount.”
On the flipside, a Canadian investor would see an expensive U.S. market at a 40% currency premium.
He attributes his outperformance to the fact that “everything is now normalizing.” The bond bull market is coming to an end, he says, value is no longer underperforming growth and the Canadian market is strengthening.
Candice Bangsund, vice-president and portfolio manager, Global Asset Allocation, at Fiera Capital in Montreal, also sees strong growth for Canada. That’s because today’s reflationary environment favours financials, materials and energy – growth-oriented sectors that constitute the majority of our stock market.
Financials, in particular, “should do well in an environment of steeper yield curves,” she says. In the U.S., they’ll benefit from Donald Trump’s deregulation plans. U.S. small caps will also benefit from deregulation, as well as from corporate tax cuts.
As for materials, they thrive in times of heavier infrastructure spending. She likes base metals such as copper. Taylor agrees, adding that Canada makes “the things you need to grow – things like cement, zinc, rebar, iron ore and lumber.”
And for energy, Bangsund says she’s targeting US$60 oil over the next year, a call that remains unchanged since the OPEC deal to curb supply. “Our base case for oil was stronger global growth; we’d already seen supply coming off in the U.S. The combination of those two was at the root of our bullish call for oil prices. The OPEC decision removes a key downside risk from the equation.”
If you didn’t overweight Canada as early as Taylor, there’s still time, he says. “In the second half a cycle, Canada outperforms, and yet we’re only one year into this.” After rate hikes in 1994 and 2004, there were multi-year bull markets, he points out. “History has shown it doesn’t end after one year.”
Outside North America, Bangsund is bullish on emerging markets but neutral on Europe. For his part, Taylor just bought a Dutch engineering company by paring his U.S. exposure. “European valuations are much more attractive than U.S. valuations,” he says. “And look where the euro is in relation to the U.S. dollar. If you’re an exporter, you’re tickled pink.”
Speaking of the greenback, “there’s likely not a lot of upside in the U.S. dollar left,” says Bangsund. “In contrast, we’re more constructive on growth-levered currencies such as the Canadian dollar.” She projects the loonie will reach US$0.80 within the next 12 months.
Taylor agrees the loonie will rise, but doesn’t have a view on when. “People think that when the Fed raises rates, the U.S. dollar does well. It does, early on,” he says. “But in every single rate-hiking cycle, the U.S. dollar has rolled over against other currencies [because] people are worried about inflation.”