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It's understandable if investors are optimistic, even a tad euphoric, about a Canadian stock market that has doubled in value since the bottom of the financial crisis in 2009. Particularly when you add in real estate surges in Toronto and Vancouver that have made paper millionaires out of even the humblest homeowners. But the mere fact that investors' fortunes have improved for almost a decade should be cause for worry. As always, you also have to look to the United States—by far the strongest force propelling the Canadian economy and markets.
There are many signs that America is near or at—or possibly past—the peak of an already historically long upswing. Pay no attention to the orange-haired tweeter in the White House for a few minutes and consider several fundamentals: The Federal Reserve has started hiking interest rates. U.S. unemployment is at a cyclical low, yet wage growth is minuscule, meaning consumers can't buy much more. Automobile sales and production have started to decline. Prices of furniture, appliances and other manufactured goods are deflating—the result of slowing demand and relentless low-wage overseas competition. Now add in trillions of dollars in federal debt and continuing political turmoil thanks to the Trump administration.
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Worried yet? There's more. For boomer investors especially, the greatest challenges will remain long after the current market cycle peters out. "The most important development over the past year wasn't Brexit or Donald Trump's election," says David Rosenberg, chief economist and strategist at Toronto-based Gluskin Sheff + Associates. "It was that the first of the baby boomers turned 70." About 1.5 million North Americans will turn 70 each year for the next 15 years. With bond yields likely to remain low for a long time, those boomers will have to invest successfully in stocks to get the income they'll need in retirement. But as they sort through Canadian stocks in particular, the choices are getting tougher.
The Canadian market has long been heavily weighted to financials and resource companies and, in many ways, it keeps getting more lopsided. When Report on Business magazine published its first Top 1000 in 1984 (ranked by profit), five of the top 10 slots were occupied by banks, and three were oil and gas companies. Bell Canada Enterprises and now-defunct liquor giant Seagram rounded out the top 10. Since then, entire sectors have been hollowed out by failures and foreign takeovers. Where are Canada's big steelmakers, nickel producers and beer companies now? Where is Nortel Networks, or more recent fallen stars like BlackBerry and even Valeant Pharmaceuticals, which came in dead last in terms of profit on this year's list?
For the first time, we've shifted to ranking the Top 1000 by revenue. In theory, that should reduce the impact of year-to-year fluctuations in the economy and individual industries, and give investors a better idea of companies' fundamental size and importance. But the names and sectors in the top 10 are still very familiar: six financial giants, Canada's biggest grocery chain and its corporate parent, auto-parts stalwart Magna International, and convenience-store champ Alimentation Couche-Tarde. At No. 11 sits pipeline leader Enbridge, with our two largest oil companies, Suncor Energy and Imperial Oil, coming in at No. 16 and No. 17.
The energy giants' strength is remarkable, given that the post-financial-crisis boom is long gone for Canada's oil and gas sector. The collapse in the price of oil from more than $100 (U.S.) a barrel in early 2014 to below $40 in 2015 led to huge declines in revenue and massive losses across the sector. But oil prices steadied at about $50 (U.S.) last year, and company earnings improved. Economists expect prices to stay there for a while.
As is the case for much of the rest of the Canadian market, however, investing successfully in the energy sector now means picking the right individual stocks. "Every company has its own story," says Douglas Porter, chief economist at the Bank of Montreal. "Each has a different mix of oil and gas, a different mix between conventional oil and oil sands, or whatever. Oil sands projects might be at very different stages of development. Even when you know all that, they might have completely different hedging policies."
Prices of other commodities have also been soft in recent years, and many foreign investors, in particular, view Canada as one big resource play. But, again, Porter says you can't generalize when looking at individual sectors and stocks. "We have quite a diverse picture," he says. "Things like lumber have been exceptionally strong lately for specific reasons. At the other end, things like nickel and natural gas have been quite weak."
The Big Six banks, of course, continue to defy gravity, both with record earnings and share prices. Yet by many measures, their shares are still remarkably cheap. The banks have traded at trailing price-to-earnings ratios of around 12 or less recently, and their dividend yields are 3.7% or more. Share prices of the other big financials, Canada's largest life insurers and the Power group of companies have struggled over the past several years, but they appear to be past the bottom at least, and their dividend yields are also above 3% or even 4%.
Indeed, Rosenberg says healthy dividends are one attractive feature that now extends across almost the entire Canadian stock market—and boomer investors need them desperately. Traditionally, investors in their late 50s and 60s have shifted from stocks to bonds and other fixed-income instruments, to provide them with income and safety. But the yield on the benchmark Government of Canada five-year bond is now just 1%, and no one expects it to climb much any time soon. "You're not going to feed your family on 1% interest," says Rosenberg.
Fortunately, dividends have come back into vogue over the past decade. In ancient times—the 1950s—they tended to be higher than bond interest, to compensate investors for the additional risk associated with stocks. But dividends fell out of favour as inflation ravaged markets in the 1970s and investors chased capital gains. "Ten years ago, the only sector of the TSX that paid a yield competitive to the bond market was the utilities," says Rosenberg. Now, he says, the average dividend yield on the S&P/TSX Composite Index is 2.7%, and "every sector pays you a yield at or better than you'll get with the Government of Canada five-year."
The hard part is putting together a diversified portfolio of Canadian stocks. To that end, we've added a stock-rating system to this year's Top 1000 ranking. Investing expert Norman Rothery—PhD in atomic physics, chartered financial analyst, founder of StingyInvestor.com and publisher of the value-stock newsletter Rothery Report—has graded the biggest stocks on the TSX from one to five stars. As Rothery explains on page 39, he used ratios and metrics associated with value and momentum styles of investing, plus measures of inherent quality, to generate his ratings. We've also added more metrics to the main stock table in the magazine, which features the top 250 companies, and to the full Top 1000 that appears online. To see the full searchable, sortable list, go to tgam.ca/top1000.
Even with these tools at your disposal, experts like Porter and Rosenberg caution that, outside of resources and financials, the choices in most sectors of the Canadian market are limited. "Occasionally, some of the other sectors can poke their heads above the wire—the classic example was the tech boom around 2000," says Porter. But he adds that Canada just doesn't have the same great opportunities in technology, health care and consumer discretionary as the U.S. market. "The very heavy dominance of just a few sectors in Canada is Exhibit A for why investors have to look outside the country in a very serious way," he says.
As for Rosenberg, he's liking Japan these days, and calls India "the new China, in terms of being a growth theatre." Europe, he adds, also appears to be promising. French President Emmanuel Macron is "a socialist who has discovered the colour of money," he says.
Whether you're investing in Canada or abroad, however, Rosenberg says now is not the time to get greedy. Today's 70-year-olds stand a better-than-even chance of living to age 85 (if they don't smoke or have high blood pressure, of course), and North America is at a late point in the cycle. Investors should learn to accept "lower returns for longer," Rosenberg says. To use a baseball analogy: "At the beginning of the cycle, you swing for the fences. At the end, you lay down bunts for singles. You preserve the runs you've scored."
John Daly is a senior editor with Report on Business magazine. Tweet at @johndaly0603