No Canada: Our home and native land a scorched tract of earth for investors lately

Opinion

Hey there, time traveller!
This article was published 22/05/2015 (3260 days ago), so information in it may no longer be current.

What happened? It’s a question many Canadian investors are asking these days when examining their portfolios chock full of homegrown companies.

Despite Canada making up only about four per cent of global markets, most Canadians have more than doubled down on investing in their homeland. According to one recent report, our stock portfolios on average are 60 per cent weighted toward domestic holdings, which means we’re about 56 per cent overweight in Canada’s market.

This may be bad news for many Canadians saving for retirement at least over the short to medium term, says Sadiq Adatia, chief investment officer with Sun Life Global Investments.

“When you’re investing in equities, you want to be sure that you have a nice basket of stocks from around the world,” says Adatia, who was in Winnipeg this week to meet with the city’s financial community.

“You have to be very cognizant of the Canadian economy and how it’s going to be underperforming over the next few years.”

For the average balanced investor who wants a 60 per cent stock/40 per cent bonds portfolio, only about 10 per cent to 15 per cent of their equity investments should likely be invested in Canadian companies, he says.

Obviously, most of our portfolios contain far more Canadian content, which can lead to lacklustre performance because our market is so heavily concentrated in a few industries (such as energy and financials).

And both these sectors have been negatively affected by the drop in the price of oil, which has been slashed in half since last summer. While the negative effects have been felt most profoundly in Alberta and Newfoundland, the ripple is expected to hit the rest of the country later this year even as prices are expected to recover somewhat.

“I don’t think we have hit the bottom yet,” Adatia says. “It’s not a V-shaped downturn with one bottom; it’s more likely a W-shape, and we’ve just gone through the first drop and come back up, so we’re probably going down again.”

Although not a doomsday scenario, lower prices — at least in the range of US$60 to US$70 for a barrel of oil (West Texas Intermediate) — could persist for years.

OPEC nations, especially Saudi Arabia, are not expected to cut production any time soon, preferring to keep the price low to put the pinch on higher-cost producers in North America.

And while the large oilsands companies aren’t expected to go anywhere, their profits are taking a big hit, and that is leading to reduced expansion and, more importantly, layoffs.

“We’re talking about a net loss of about $40 billion in lost revenue,” Adatia says. “That equates roughly… about a two per cent GDP hit to Canada.”

Compounding problems is we’re highly indebted, and not just our governments. Canadian households on average owe $1.63 for every dollar of income, a figure that has been rising for several years.

Adatia says this will eventually stifle growth.

So far, it hasn’t. We’ve been able to maintain consumption because of low interest rates that make it cheap to borrow.

“If you look more closely at this, though, you’ll start to ask, ‘If Canadians have tacked on so much debt, how are they going to continue to support the economy when they really have no more room to take on debt?’ ” he says. “Eventually, they will cut back on spending and focus on saving.”

This would also have an effect on real estate — a market Adatia says is ripe for a pullback. “Our estimates are it’s about 30 per cent overvalued.”

All of these conditions make for an economic maelstrom. Increasingly indebted Canadians are less likely to be able to afford bigger and better housing, which in turn depresses real estate prices.

And that affects the economy — already hurt by the downturn in the oilpatch.

Yet, not all is lost.

Canadian companies that rely on oil inputs for their business will see an improvement to their bottom line. Airlines and manufacturers should see reduced costs for energy, which should increase their profitability — and ability to hire. Yet, a job added in manufacturing isn’t equal to one lost in the energy sector, Adatia says.

“It’s not a one-for-one equation, because there is still a net loss in overall wealth because energy jobs pay so well.”

Still, oil prices shouldn’t remain low forever. He says OPEC nations may have lower production costs, but they also rely heavily on higher-priced oil to fund their government expenditures. “In addition, demand is likely to go up because of growth in emerging markets, so there will be additional need for supply just to meet demand — eventually.”

And for investors, the energy sector probably offers buying opportunities for those who can stomach a rough go in the short run.

“If you have a longer-term outlook, there are some great energy companies that are cheaply priced right now that should pick up in the next three to five years because we don’t see oil prices remaining around the US$50-a-barrel price for that long.”

In the meantime, investors can focus on opportunities abroad, ensuring their portfolio reflects the global marketplace. And the emphasis should still be equities over bonds.

“When you think about the reward versus risk trade-off it’s not as strongly in favour of the reward side on equities as it was a couple of years ago,” Adatia says.

“At the same time, we’re in a scenario where bond markets are not going to give you the return that we’ve seen in the past, and there’s the potential to see their values decline, and that’s something most Canadians investors are not accustomed to.”

The U.S. is still expected to perform as well if not better than other parts of the world, even if the Federal Reserve hikes interest rates.

“When you see rates increase, you have to think about the reason,” he says. “In the case of the U.S., it would be because the economy is improving, so that’s a good sign.”

Eventually, a series of rate hikes south of the border is likely to spur a sell-off in equities, but Adatia says he doesn’t expect that to happen until at least the end of 2016.

Perhaps the biggest challenge today for U.S. markets is expectations are now higher than in past years. Risk aversion is falling; more investors are back in the market.

This can make it more difficult to provide the good returns experienced in the last few years. Emerging markets may be the exception, however, because they generally do best in times of high investor confidence in other markets, Adatia says.

Despite their muted prospects in the coming year or two, equities are the place to be even for income investors who traditionally gravitate to bonds.

“For the time being, you’re still seeing much better yields in the equity market than in the bond markets,” Adatia says, adding current yields on 10-year U.S. bonds are about two per cent.

“Until you start seeing 10-year government bond yields in the U.S. at three (per cent) to 3.5 per cent, I still think the opportunities are better in the stock market than in the bond market.”

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