The Canadian stock market has trailed other markets and is down so far in 2018. Growing company profits have done little to revive stock prices. We’re not comfortable sounding like TV pitchmen, but you really should buy high-quality Canadian stocks at these prices.
In February, the Canadian economy grew by 0.4 per cent. Out of 20 industrial sectors, 15 expanded. In all of 2018, the country’s GDP (Gross Domestic Product) is expected to rise by 2.2 per cent.
Faster economic growth should drive up company profits. This, in turn, will make Canadian stocks even better bargains relative to foreign—and particularly US—stocks. Lower share prices and growing profits give Canadian stocks more favourable forward price-to-earnings ratios. Eventually, Canadian company earnings will become too good to ignore. As we often point out, in the long run it’s the direction and amplitude of company earnings that set stock prices.
The big five Canadian banks fit the bill
You should continue to buy some solid Canadian stocks, such as the Big Five banks (Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Royal Bank of Canada and Toronto-Dominion Bank). They all pay attractive dividends. And thanks to their ongoing earnings growth, the Big Five raise their dividends every year. These ‘dividend aristocrats’ will draw income-seeking investors who will bid up the banks’ share prices. We believe that the big banks will easily overcome the recent real estate setback.
The outlook for the Canadian economy is positive in some respects. One is that US GDP is expected to expand by 2.8 per cent this year—the fastest of the G7 (the Group of Seven industrial countries). With the US accounting for about three-quarters of Canada’s exports, faster growth south of the border should lift Canada’s growth.
What’s more, the US economy is already operating near or at its capacity. As President Trump’s $1.5 trillion tax cut jolts the economy, we expect imports, including Canadian exports, to make up at least some of the production shortfall. Especially if President Trump makes good on his pledge to renew American infrastructure and make it better than the infrastructure of all other countries.
Trade agreements may bring mixed blessings
Ironically, the US is also the greatest source of uncertainty for Canada’s economic growth. One risk is the renegotiation or scrapping of NAFTA (North American Free Trade Agreement). A second risk is rising inflation in the US (see below).
But Canada also stands to profit from recent comprehensive trade agreements with the EU (European Union), the TPP (Trans Pacific Partnership) and South Korea. The TPP includes Japan (the world’s third-largest economy), Australia, Chile, Malaysia, New Zealand, Singapore and Vietnam, among others).
Inflation and investments
We also expect inflation to accelerate. That’s because US demand will jump while it’s already operating near or at capacity. Also, there’s synchronized upswing in the global economy.
Accelerating inflation is always negative for existing bonds. The fact is, higher inflation leads to higher interest rates. The only way that existing bonds can pay as much as newly-issued bonds is if their prices go down.
Accelerating inflation may have little effect on stocks. For one thing, companies can offset higher costs by raising prices. For another, inflation can magnify a company’s reported profits. So make sure that your well-diversified portfolio includes high-quality stocks.
Beat foreign investors to the punch by buying high-quality Canadian stocks at low prices. Keep those overseas and American stocks that have few or no Canadian counterparts.
This is an edited version of an article that was originally published for subscribers in the May 11, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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