Friday, October 2, 2009

David Rosenberg Makes the Case for Canada as a Low Beta Emerging Market Play

Preface: for those not familiar with David Rosenberg, he is a very well known economist (some claim a relative perma bear) who made the move over from Merrill Lynch to a Canadian firm Gluskin Sheff, earlier this year. While having mostly missed this rally, much of what he says deals more with the long term structural issues we bring up - rather than any tactical short to mid term trading concepts.

Reader 'SKS' pointed us to this article from the Toronto Globe & Mail in which he makes the case for Canada as a "low beta way to play the emerging markets via commodity exposure". You will also notice the side by side "sector" weighting in the major indexes of the S&P 500 versus TSX.

Please note, from my general understanding the Canadian banking system is dominated by 5 major banks (an argument against "too big to fail") but they are highly regulated (an argument for regulation).
  • Banking in Canada is widely considered the most efficient and safest banking system in the world,[1] ranking as the world's soundest banking system according to a 2008 World Economic Forum report.
But as the globe expands and modernizes the real juice will be in Canada's commodity exposure, very similar to the situation in Australia.
  • I stand accused of having missed the turn and that accusation comes from the throngs who believe that the only way to generate a positive return is through the equity market. You see, for so many pundits, you are labelled a “bull” or a “bear” based on how you feel about the equity market. You turn on the various business shows on bubble-vision and it's all about equities; one would think that there is no other market on the planet.
  • Equities continue to grab the imagination of the investment public even though they are now barely halfway through a secular bear market – a long-term, flat-to-down cycle – that is likely to last 18 years. This does not mean that cyclical bull markets cannot occur in the meantime – they did even in the 1930s and in Japan in the 1990s. The S&P 500 has even managed to reach two historical price peaks (September, 2000, and October, 2007) during the current secular bear market phase.
  • My contention is that the commodity market entered a secular bull market right around the same time that the equity market entered its secular bear market – a tad later actually, in November, 2001.
  • Not surprisingly, the last secular bear market in equities, from the mid-1960s to the early 1980s, also took hold alongside a secular bull market in commodities; we are seeing something very similar take hold this time around but for very different reasons.
  • What really caught my eye this time was that during the vicious selloff in commodities last year, the price of virtually every commodity bottomed at a higher price than during any other recession in the past.
  • I always cringe when I hear the words “it's different this time,” but in fact, in the case of the resource sector, this indeed seems to be the case. Why? It's all about the shifts in the supply and demand curve.
  • On the supply side, we have a much more concentrated sector, with fewer players than in past cycles following the wave of global consolidation over the past decade, in particular. Moreover, the executives of these resource companies are business people, not geologists, and as such have been much more disciplined from a production standpoint.
  • On the demand side, an emerging Asia climbed out of its depression just over a decade ago with restructured economies, vastly improved balance sheets and changed political landscapes.
  • What we refer to as emerging markets once commanded more than half of global GDP before the industrial revolution, and are on track to regain that lost share in coming decades; likely sooner rather than later.
Canada v US
  • This is where Canadian strength relative to the United States comes into play – nearly 45 per cent of the TSX composite index is in resources; almost triple the share in the United States.
  • Almost 60 per cent of Canada's exports are linked to the commodity sector, roughly double the U.S. exposure.
  • Canada is basically a low-beta way to play the emerging markets via commodity exposure.
  • Moreover, considering that the Canadian dollar enjoys a 65-per-cent correlation with the CRB index, the added boost from the appreciation in the loonie means that an American investor putting money in Canada would have garnered a 28-per-cent gain on a currency-adjusted basis (versus a 4.0-per-cent gain from the S&P 500).
  • If the history of long cycles is any indication, this period in which the Canadian market outperforms its southern peers is barely halfway done.
No position

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