Canadian Stocks to Trail U.S. Equities, Russell’s Wood Says

Canadian stocks are likely to lag behind their U.S. peers for the rest of the year as Chinese efforts to cool its economy restrain commodity prices, said Stephen Wood, chief market strategist at Russell Investments.

The Standard & Poor’s 500 probably will gain about 6.5 percent through Dec. 31, Wood said, compared with Russell’s S&P /Toronto Stock Exchange Composite Index forecast of a 4 percent to 5 percent increase. That means the U.S. benchmark could outperform the S&P/TSX this year for the first time since 2003.

“If you look at the fundamentals of Canada, they’re very strong,” Wood said in an interview in Toronto yesterday. “But you’ve got this wild card, this Damoclean sword: What is China going to be able to accomplish? That probably makes the U.S. percentage-competitive and maybe a little bit better in the medium term.”

The S&P/TSX rose 1.4 percent in the first eight months of the year, aided by a 14 percent surge in gold prices, while the S&P 500 fell 5.9 percent. This month through yesterday, the S&P 500 led developed-market benchmarks with a 9.4 percent jump while the S&P/TSX advanced 3.1 percent.

That trend should continue over the next several months as China tightens policy to prevent asset bubbles, said Wood, who works in New York for Tacoma, Washington-based Russell, which manages $140 billion.

“It could be a neck-and-neck race for 2010,” Wood said. “2011 is going to be relatively competitive as well.”

China’s Influence

Energy and raw-materials companies make up 47 percent of Canadian stocks by market value. China is the world’s largest copper consumer and second-biggest user of oil behind the U.S.

Since the S&P/TSX began outperforming the S&P 500 in 2004, copper and oil prices have more than doubled due largely to demand from China and other emerging markets.

Since reporting a record rise in property prices for March, China has imposed restrictions including higher down-payment and mortgage rates for multiple-home buyers and instructions for lenders to halt third-home loans in areas with “excessive price gains.”

“Are they past the halfway point of their tightening cycle? I think that’s a reasonable expectation,” Wood said. “Are they at the end of their tightening? I don’t think so. That will be the end of 2010, beginning of 2011.”

China should successfully ease economic growth to an annualized rate of about 8.5 percent over the next six to nine months from 11.1 percent in the first half of 2010, Wood said.

Strong Currency

In addition, a strong Canadian dollar will discourage investment flows from other countries, Wood said. The Canadian dollar has fluctuated between 93 U.S. cents and $1 this year, compared with a 10-year average of 81.3 cents.

Investors may also be starting to question the premium Canadian stocks have received over U.S. equities over the past year. Compared with S&P 500 companies, S&P/TSX stocks now cost 25 percent more per dollar of estimated profit over the next year. Since the end of 2005, Canadian stocks’ premium has been 0.7 percent.

“From a currency perspective, and from a valuation perspective, is Canada, after six consecutive years of outperformance, rich relative to expected future growth? That’s a very good consideration,” Wood said.

Mergers and acquisitions in the natural-resources sector may jeopardize the forecast, Wood said. A single offer, such as BHP Billiton Ltd.’s $40 billion unsolicited bid for Potash Corp. of Saskatchewan Inc., can move the Canadian market enough to throw estimates off.

Potash Corp. and Red Back Mining Inc., which Kinross Gold Corp. acquired on Sept. 22, accounted for 134.48 points of the S&P/TSX’s 561.42-point year-to-date gain through yesterday.

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