Toronto Stocks Seen Trailing U.S. Market for Third Year

Canadian stocks will trail U.S. equities for a third straight year in 2013 as economic growth fails to keep pace with a global recovery, a survey of strategists found.

The Standard & Poor’s/TSX Composite Index is expected to finish next year at 12,886, up 4.1 percent from the Canadian gauge’s level on Dec. 27, according to the average estimate of seven strategists surveyed by Bloomberg. The S&P 500 Index will advance 8 percent in 2013, based on the average estimate of 14 strategists. The U.S. benchmark measure last underperformed the S&P/TSX (SPTSX) in 2010, the end of a seven-year streak of outperformance by the Canadian index.

The S&P/TSX fell 57.65 points, or 0.5 percent, to 12,316.12 in Toronto today. The benchmark Canadian equity gauge has trailed markets in every developed nation this year except for Portugal and Spain.

“There’s so much noise out there, with the European situation, China had a slowing economy this year, and the U.S. has been kicking the budget can down the road for a while,” said John Kinsey, fund manager with Caldwell Securities Ltd. in Toronto, which manages about C$1 billion ($1.01 billion). “The market is going to be similar to what we saw in 2012, but on balance we do feel we will be moving forward.”

The S&P/TSX will be hampered in 2013 by record levels of consumer debt and a housing market that is showing signs of slowing, analysts said. That is likely to weigh on financial shares, tempering any gains among energy and raw-materials companies from a possible rebound in China’s economy.

Canadian shares rose 3.5 percent in 2012 to yesterday, trailing a 13 percent rally in the S&P 500. The S&P/TSX plunged as much as 11 percent from the year’s high in February as European leaders wrestled with the region’s debt crisis. After recovering to reach a seven-month peak in November, the index has since slipped 1 percent as U.S. lawmakers struggled to reach a budget accord and avoid more than $600 billion in automatic tax increases and spending cuts.

China Slowdown

Equities have also been weighed down by the underperformance of commodity shares, which have been hurt by slowing growth in China. Raw-material companies are the worst performers of 10 major industries in the benchmark index this year, falling 8.5 percent as of yesterday, according to data compiled by Bloomberg. Energy shares are down 4.3 percent for 2012.

The Chinese economy has decelerated for seven straight quarters, to 7.4 percent growth in the third quarter, the slowest pace in three years. China, the world’s second-largest economy, is a major consumer of Canadian raw materials.

For Canada next year, “it’s all contingent on what happens in China,” said Luciano Orengo, fund manager with Manulife Asset Management Ltd., in a phone interview from Toronto. His team manages about C$1.4 billion.

New Leader

With Xi Jinping set to become the country’s new president in March, analysts expect the party leadership to stimulate the economy to encourage a turnaround. China’s gross domestic product is expected to accelerate to 7.8 percent in the fourth quarter of 2012 and will improve further through the first half of 2013, according to analysts’ estimates as surveyed by Bloomberg.

“The upside story for China can be substantial for materials,” said Shailesh Kshatriya, senior investment analyst with Russell Investments Ltd. in Toronto. “There’s still a lot of room for urbanization in the rural areas in China, opportunities for base metals to move higher.”

Teck Resources Ltd. (TCK/B), Canada’s largest diversified mining company which produces metallurgical coal, copper and other base metals, is poised to benefit from any increased infrastructure spending. Teck fell 0.9 percent in 2012 and traded at a 32 percent discount to the S&P/TSX Materials Index as of yesterday, data compiled by Bloomberg show.

Cost Overruns

The outlook for mining shares is not as promising even with a rise in gold prices, said Vincent Delisle, investment strategist with Scotia Capital Inc.’s portfolio strategy group.

“The issue is cost overruns,” he said while presenting his 2013 equity outlook in Toronto, referring to rising costs for many gold producers developing large-scale projects.

Barrick Gold Corp. (ABX) has raised the cost estimate for its Pascua-Lama project on the border of Chile and Argentina twice this year, most recently to as much as $8.5 billion in November. Barrick and Goldcorp Inc., the world’s two largest producers, have fallen 26 percent and 20 percent, respectively, this year.

Gold prices, meanwhile, have risen 6.2 percent in 2012, set for a 12th straight annual gain on the back of widespread monetary stimulus from central banks around the world.

“Gold equities have brought an extra level of risk in the past 18 months and that is a very difficult hurdle to surmount,” Delisle said. “Copper, oil, iron ore, and other industrial materials are much more levered to China.”

Heavy Oil

Brandon Snow, a fund manager with Cambridge Advisors, a unit of CI Investments Ltd., said he is considering buying into heavy oil producers such as Canadian Natural Resources Inc. and Baytex Energy Corp. His firm manages about C$5.8 billion.

“Heavy oil is what you want exposure to,” said Snow, whose Cambridge Canadian Equity Corporate Class fund outperformed 56 competitors this year with a 17 percent gain, according to data compiled by Bloomberg. Heavy oil is a type of crude commonly produced in the oil sands that has a higher consistency than the West Texas Intermediate standard.

The spread between WTI and Western Canadian Select, which is the traditionally discounted price at which Canadian heavy crude trades, has widened over the past year to as much as $42.50. This compares with a $15.87 average spread over the past four years, according to data compiled by Bloomberg.

Oil production grew much faster in 2012 than anyone expected, Snow said, substantially lowering demand for Canadian oil in the U.S. This pricing factor is “unlikely to repeat” and he expects the spread to return to more normal levels next year.

Housing Market

The single biggest risk for the S&P/TSX, and especially for financials that account for 33 percent of the index, remains the Canadian housing market and attendant record-high consumer debt levels, said Russell’s Kshatriya.

“Financials will be challenged due to the housing slowdown,” he said. “The direct profitability of the commercial banks will be affected by consumers borrowing less.”

Consumer credit-market debt such as mortgages rose to a record 164.6 percent of disposable income in the third quarter, according to Statistics Canada. Mark Carney, governor of the Bank of Canada, has repeatedly warned Canadians to avoid pushing their debt levels any higher.

The International Monetary Fund, in a report on the Canadian economy on Dec. 19, said house prices and residential investment as a share of GDP is higher than levels “consistent with economic fundamentals” and recommended the nation should use regulation to avoid a further buildup of household debt.

Canadian GDP

The IMF forecasts Canadian economic growth of “just below 2 percent” in 2013. Economists estimate the global economy will expand at a pace of 2.4 percent next year, faster than the 2.2 percent predicted for 2012, according to data compiled by Bloomberg.

Sadiq Adatia, chief investment officer with Sun Life Global Investments Inc., said the Canadian economy has become vulnerable due to its resilience through the 2008 global financial crisis, which led to a housing boom amid low interest rates held at 1 percent since September 2010.

“After 2008, every economy in the world had a process of deleveraging, fixing up their balance sheets and getting set up for growth down the road. Canada was the only one that didn’t,” he said. “At some point, we have to do it, and we will see Canada take its step back in 2013.”

To contact the reporter on this story: Eric Lam in Toronto at elam87@bloomberg.net

To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net

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