Canada: Investing in the 'World's Safest Economy'

Includes: EWC, SU, TD, TECK
by: Martin Hutchinson

By Martin Hutchinson

When a March 25 "no-confidence" vote toppled the government of Canadian Prime Minister Stephen Harper, it also set the stage for a new general election.

This May 2 election will be Canada's third in five years and fourth in seven years. In light of the civil unrest in the Middle East/North Africa (MENA) region - not to mention the financial problems that continue to plague Europe - it would be understandable if global investors added Canada to the "do not invest" list.

But don't make that mistake: Our neighbor to the north remains one of the most stable big-market profit plays on the planet today.

Some investors even refer to it as the "world's safest economy." And with good reason.

High Upside

Any worries about political stability are essentially groundless - and for two very good reasons:

  • First, opinion polls currently show a result almost identical to that of the previous election in 2008.
  • And, second, even a left-of-center coalition between the Liberals and the new Democrats would make only modest changes to Canada's stable economy.
The Economist team of forecasters projects Canada's growth at 2.6% to 2.8% in 2012. That forecast puts Canada's economic growth rate at slightly below the growth rate of its U.S. counterpart, but I believe that it's a bit pessimistic - Canada's growth has been running at well over 3% for the last year.

Canada's inflation rate is very similar to that of the United States, while its payments deficit is actually a bit less (it has risen recently, due to the rising Canadian dollar - a currency that's known as the "loonie"). But with a budget deficit of about 2.1% of gross domestic product (GDP), Canada's deficit situation is much better than it is here in the United States.

(In the Congressional Budget Office's (CBO) economic outlook report (pdf), the nonpartisan body recently estimated the U.S. budget deficit would reach $1.5 trillion in 2011, or 9.8% of GDP.)

Monetary policy is a bit tighter in Canada than it is here in the United States: The Bank of Canada has its target interest rate at 1.0%, while policymakers at the U.S. Federal Reserve have the benchmark Federal Funds rate at 0.00% to 0.25%.

And it's not just in terms of fiscal and monetary policy that's seen Canada achieve a better overall economic balance than its U.S. counterpart: Canada has a relatively larger resources sector, too - a major advantage when energy and commodity prices are driven upward by Asian demand.

Low Risk Politically

Since 2006, Canada has been run by a minority Conservative government, headed by Harper. The Harper government acted with great prudence during the financial crisis, succumbing only mildly to the (ill-advised) joys of bank bailouts and "stimulus."

Needless to say, the country has been greatly aided by the fact that Canada's banking and housing sectors were much more conservative than their U.S. counterparts, and had no equivalents of Fannie Mae (FNM-R) and Freddie Mac (OTCQB:FMCC).

If Canada has erred, it has done so with its tendency to succumb to trendy environmental nostrums - for instance, banning permission on specious grounds for a highly beneficial gold mine project of Taseko Mines Ltd. (AMEX: TGB).

That's why there is not much political risk. The Liberal Party of Canada, the main alternative to Harper, is not particularly left-wing. It had an excellent record of fiscal prudence in the office in the 1990s when it brought Canadian government spending down from levels that threatened bankruptcy, and is only mildly more liable to succumb to foolish and economically damaging nostrums than the Conservatives.

Its likely partners in a minority government, the NDP, are more leftist, close in approach to the British Labour party, but are not likely to be strong enough to force policy changes of any substance.

Moves to Make Now

There are a number of possible approaches to investing in Canada. One is to buy the market as a whole, investing in the Canadian market exchange-traded fund, the iShares MSCI Canada Index ETF (NYSE: EWC). That fund has a Price/Earnings (P/E) ratio of 16 and a yield of 1.5% currently, so the Canadian market overall is reasonably priced.

A second possible approach is to buy one of the five large Canadian banks, where Canada has a clear competitive advantage over the United States because of better regulation. Of these, I like the Toronto-Dominion Bank (NYSE: TD) best. That's trading at 16 times earnings, with a nice dividend yield of 3.2%. Its Price/Book (P/B) Value ratio is a reasonable 2.0, while its P/E falls to 11.9 on expected 2012 earnings.

Rather than Canadian industrials, I prefer to concentrate my non-bank Canadian holdings in the resources sector. Canada's most important strategic relationship with the United States is in the supply of energy, both from conventional oil and gas and from the Athabasca tar sands deposits in Alberta.

Of the Canadian oil plays, I most like Suncor Energy Inc. (NYSE: SU), because of its position as the most important producer of tar sands oil. This is only modestly profitable at current oil prices, but if prices run up or a global crisis restricts supplies, Suncor can be expected to increase hugely in profitability. It is currently at 19 times trailing earnings, but only 16 times expected 2012 earnings (which probably have not been adjusted for oil prices well above $100 per barrel).

Finally, in Canada's very important minerals sector, I like Teck Resources Ltd. (NYSE: TCK) which is a major producer of coal, copperand other metals. It has the Chinese government's China Investment Corp. sovereign wealth fund as a 17% strategic shareholder (one of CIC's few really profitable deals, up over 100% since it bought close to the bottom of the market).

Teck is trading at a reasonable 16.5 times earnings, and a remarkably reasonable 8.4 times expected 2012 earnings. It is due to benefit further from the global scarcity in copper and from completion of coal infrastructure, enabling it to ship efficiently to the Chinese market from Canada's West Coast.

Canada offers a diversification from the U.S. economy, exposure to the booming minerals sector and very little extra risk. You should have some money there.

Disclosure: None

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