Photographer: Michael Nagle/Bloomberg

How Investors Should Handle Cold Stocks in Canada's Hot Economy

  • Benchmark S&P/TSX completes first quarterly drop since 2015
  • Strategists recommend Canadian financial stocks over energy

The world’s fastest-growing developed economy has the worst-performing stock market, creating buying opportunities especially for investors in Canada’s financial sector.

The S&P/TSX Composite Index is down 2.4 percent from April to June, its first quarterly drop since 2015 and the steepest decline among 24 advanced markets tracked by Bloomberg. Year-to-date, its 0.7 percent dip compares with returns of 8.2 percent for the S&P 500, 7.4 percent for Germany’s DAX and 17 percent for Hong Kong’s Hang Seng.

Weakness in commodity prices, particularly oil, along with fears of an overheated property market and the potential fallout from troubles at Home Capital Group Inc. were the main reasons for Canada’s underperformance. Now, some commodities are rebounding, house prices are cooling, consumers are continuing their free-spending ways, and Warren Buffett just bought a stake in Home Capital.

All of this is prompting strategists to predict a bit of a rebound for Canada. David Rosenberg, chief economist and strategist at Toronto-based wealth management firm Gluskin Sheff + Associates Inc., sees the S&P/TSX gaining 5 percent over the next six to 12 months, though he believes financial stocks could double that return, particularly if the Bank of Canada starts to raise interest rates as signaled.

"The financials in Canada look very attractive to me, both in terms of fundamentals and valuation work that I’ve done," Rosenberg said in a phone interview. Energy stocks, by contrast, remain "far too speculative" to warrant an investment at this stage, he said.

The view is echoed by Derek Massey, head of portfolio management and private investment at HSBC Bank Canada.

"The Canadian financials are one sector that we’re looking at adding to in the coming year," Massey said. "You have valuations on Canadian banks that are quite attractive at this stage, you’ve got a really nice dividend across the board and one of the most secure dividend policies almost anywhere in the world."

The S&P/TSX financial index has lost 1.8 percent this quarter compared with a 3.8 percent gain for its U.S. counterpart. Canadian bank stocks have rebounded in the past few weeks, boosted by rising bond yields and easing Home Capital worries. The commercial banks index has gained 3.7 percent since its low on May 17.

The recent rebound in the loonie -- up 5.8 percent from its recent lows -- could also help boost Canadian stocks.

"With the Canadian dollar bottoming and financials not imploding, we smell a surprise recovery coming," Brian Belski, chief investment strategist at BMO Capital Markets, wrote in a note to clients. "It is likely time to take a more contrarian view on Canada, as we believe the excessively negative sentiment toward Canadian equities is overdone."

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