The Hot Foreign Market Right Next Door

If you're worried that Wall Street's rally is losing momentum, now is an ideal time to take a fresh look at foreign markets. One of the most promising is right next door: the Toronto Stock Exchange. The TSE's 300 Composite Index rose 7.5% in the first quarter, nearly double the gain posted by the Standard & Poor's 500-stock index. And many analysts believe it's only the beginning of a sustained bull market. Toronto should outperform U.S. markets "for the next two to three years," predicts Alexander Christ, chairman of Mackenzie Financial, a Toronto mutual-fund company.

With the TSE trailing U.S. exchanges through much of the past decade, until recently Toronto was about the last place Americans wanted to invest. Over the past three years, Canadian stocks have been hammered by weak commodity prices, a recession that hit Canada far harder than the U.S., and a massive restructuring of industry. The upshot is that Toronto is one of the few markets that haven't fully recovered from the 1987 crash. Even after the strong first quarter, the TSE 300 is hovering around 3600, well below its August, 1987, record high of 4112.86.

That's another way of suggesting many TSE stocks are underpriced, especially compared with their American counterparts. Subodh Kumar, chief strategist at Wood Gundy, estimates the TSE is trading at about 14 times projected 1993 earnings, vs. 17 times for the S&P 500.

Kumar and other analysts believe a dramatic improvement in fundamentals is paving the way for a resurgence in values. For starters, the Canadian economy is now climbing out of recession and is expected to grow 3% this year. That should help produce a healthy rise in corporate profits.

RECORD TRADING. Meanwhile, falling interest rates are sparking a major move back into equities. The trend is so strong that the TSE set new trading records in March. Even the political outlook is improving. Until February, it looked as if Canada's ruling Progressive Conservative Party was heading for a crushing defeat in this year's national elections. But since Prime Minister Brian Mulroney announced he would not run again, his party's chances have improved enormously. A Conservative victory "would be worth hundreds of points" in the market, says Michael Graham, director of private- client investment at Midland Walwyn.

Kumar figures the TSE could hit 3900 by yearend, with a total return, including dividends, of 20%--more than double what he expects from the S&P 500. And many analysts think that the TSE will build on those gains in the next two years, as a world recovery fuels price increases in the commodities Canada supplies.

The easiest way for Americans to get in on the action is to buy one of the few mutual funds that specialize in Canadian securities, such as Fidelity Canada and Mackenzie Canada funds. Both far outstripped the average return of just over 3% posted by U.S. equity funds in the first quarter. Fidelity Canada was up 11.4%; MacKenzie's fund soared 26.6%.

It's almost as easy to assemble your own portfolio. Some 200 Canadian stocks are listed on one of the three New York exchanges. Any big U.S. brokerage could place your orders for hundreds more listed only on the TSE.

NATURAL RESOURCES. In contrast with U.S. markets, the TSE is heavily skewed toward natural-resource stocks. Most analysts expect at least some sectors to outperform the market as a whole. In the forest-products industry, lumber has already surged, but pulp and paper "are about to do much better," says Jim Doak, research director at Scotia McLeod Inc. He recommends two companies in this field: MacMillan Bloedel and Abitibi-Price.

Energy stocks are another favorite, thanks in part to the improving outlook for natural gas. But Philip Heitner, research director at Nesbitt Thomson Inc., suggests focusing on midsize producers "who've been performing especially well." His favorites include Renaissance Energy, Total Canada Oil & Gas, and Elan Energy. For a broader-based play on a resource recovery, you might consider the stock Graham says is "tailor-made for a world economic recovery": diversified resource giant Noranda.

Beyond resource stocks, George Domolky, portfolio manager of the Fidelity Canada Fund, is high on the retailer Hudson's Bay. He also likes Rogers Communications, a major player in the cable-television and cellular-phone industries.

Finally, many analysts suggest taking a flyer on the big Canadian banks. They were clobbered by loan-loss provisions during the recession as a result of enormous bets on real estate--notably projects by developer Olympia & York. But with the write-downs behind them, the stocks are set to improve. Ben Joyce, chief equities strategist at Burns Fry, likes Canada's Big Three: Royal Bank of Canada, Canadian Imperial Bank of Commerce, and Bank of Montreal.

Analysts don't see much currency risk for Americans. With the Canadian dollar worth around 80 superscript 2 U.S., "it has found its equilibrium," says Fidelity's Domolky. But there are other potential pitfalls in investing up north. A hung Parliament or fallout from Canada's huge government debt burden could depress the market. Even so, things haven't looked this promising in Toronto for years. And there's still time for American investors to join the party.