The Commodity-Driven Canadian Economy Is Now In Recession

Canada is primarily a resource-based economy with oil and minerals accounting for a major source of export revenue. As the price of oil plunged in the past year or so, commodity-based economies such as Brazil, Russia, Australia, Canada, etc. are suffering. After being resilient for a few months, the Canadian economy has now officially entered recession. From a recent article in the BBC:

The Canadian economy has entered recession, official figures have shown.

Gross domestic product (GDP) fell by an annualised rate of 0.5% between April and June.

That follows a contraction of 0.8% in the first quarter, meaning the economy has seen two consecutive quarters of negative growth, the usual definition of recession.

Source: BBC

The Journal published an article today on the Canadian economy and natural resources-based economies in general. From that piece:

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Canada Export Composition

In Canada, the oil-price collapse and recent market turmoil have pushed its dollar down to 11-year lows against that of the U.S., its biggest trading partner. Policy makers have pointed to the lower dollar as the silver lining of the commodities rout, since it is expected to help manufacturers and exporters.

But the manufacturing sector, concentrated in Quebec and Ontario, was hollowed out during the years the Canadian dollar traded at or near par with the U.S. dollar, and by the recession that followed the financial crisis.

Now many economists say Canada is no longer competing with the U.S. to regain factory jobs. Instead, both Canada and the U.S. are losing those jobs to lower-cost Mexico.

Source: Canada Illustrates Plight of Rich but Resource-Dependent Countries, Sept 2, 2015, WSJ

Though the economy is in contraction mode now, Canada offers many opportunities for investment in select sectors. Here are a few positive factors the Canadian economy:

The banking industry is very strong and is highly regulated. Though a handful of banks dominate the industry is much better than the US banking industry for a variety of reasons. For example, concepts such as sub-prime mortgages or NINJA (No Income No Job No Assets) loans are virtually unheard of in Canada. In addition, all mortgage loans are recourse loans – meaning the lender can after a defaulted borrower to recover the full amount of a loan – and borrowers can mail in the keys and escape free.

As the chart above shows, automobile and parts manufacturing is also a big industry especially in the provinces of Ontario and Quebec. The U.S. is Canada’s largest trade partner and one of the big exports category to the U.S. is automobiles. Hundreds of Canadians are employed in this industry and American auto makers prefer Canada in some ways over Mexico. For instance, unlike in the U.S. auto makers benefit tremendously from not having to offer healthcare benefits to Canadian workers since the state offers universal healthcare to all. In the US, healthcare costs is a major drag for auto makers.

Railroad is another industry that investors can consider for long-term investment. With just two railroads dominating the entire industry in the country, it is a no-brainer to invest in them. Though oil shipments may have slowed, rails are still the preferred means of transport for agricultural, timber and automobiles. Hence railroad operators will benefit from a growing US economy.

From an investment point of view, investors may consider adding Royal Bank of Canada(RY)  and Toronto Dominion Bank(TD) in the banking sector, railroad operator Canadian National (CNI) and auto-parts maker Magna International(MGA)

Disclosure: Long RY,TD,MGA, CNI

Ten Emerging Markets Stocks To Consider For Potential Investment

Emerging markets have performed poorly so far this year. While this year’s meltdown in emerging markets can be attributed to China’s economic slowdown, some emerging markets such as Brazil have been in a downward trend for a few years now due to domestic issues.

The widely-followed MSCI Emerging Markets Index is down by over 4% as of the end of July. The following chart shows the long-term performance of the index and the annual returns:

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MSCI Emerging Markets Chart

Source: MSCI

The iShares MSCI Emerging Markets (EEM) which tracks the index is down 14% year-to-date. Since markets worldwide fell dramatically this month (which is not included in the chart), the chart above shows only single digit losses.

However despite the big selloffs in emerging equities, long-term investors can find opportunities in those markets. According to an article by Emerging Markets guru Mark Mobius, bull markets in emerging markets have lasted longer than bear markets in the past. While this does not necessarily predict the behavior of the markets in the future, it is still worth taking note in order to select stocks that can profit from the potential growth of emerging markets.

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Emerging Markets-Bull and Bear Market Durations

Source: On Market Corrections, and Keeping a Calm Head, Franklin Templeton Investments

In developing countries, certain sectors are better to invest in than other others. For example, companies in the banks, utilities, consumer staples sectors offer better options than those in tech, internet. mining, etc. sectors.

Ten stocks from emerging markets are listed below for adding in phases to a well-diversified portfolio at current levels:

1.Company: Ecopetrol SA (EC)
Current Dividend Yield: 10.31%
Sector: Oil & Gas Producers
Country: Colombia

2.Company: Bancolombia S.A. (CIB)
Current Dividend Yield: 4.00%
Country: Colombia

3.Company: Standard Bank Group Limited (SGBLY)
Current Dividend Yield: 4.68%
Sector: Banking
Country: South Africa

4.Company: Banco de Chile (BCH)
Current Dividend Yield: 5.16%
Country: Chile

5.Company: Itau Unibanco Holding SA (ITUB)
Current Dividend Yield: 5.45%
Sector: Banking
Country: Brazil

6.Company: HDFC Bank Ltd (HDB)
Current Dividend Yield: 0.64%
Sector: Banking
Country: India

7.Company: Coca-Cola Femsa SAB de CV (KOF)
Current Dividend Yield: 1.43%

8.Company:Fomento Economico Mexicano SAB de CV (FMX)
Current Dividend Yield: 0.82%

9.Company: Malayan Banking Berhad (MLYBY)
Current Dividend Yield: 7.88%
Sector: Banking

10.Company: Ultrapar Participacoes SA (UGP)
Current Dividend Yield: 2.50%
Sector: Oil, Gas & Consumable Fuels
Country: Brazil

Note: Dividend yields noted above are as of Aug 28, 2015. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: Long EC, BCH, ITUB

S&P 500 Companies’ Sales By Country

Last year I wrote an article on why investing in U.S. multinationals is not the same as investing in foreign companies. From that article:

Michelle Gibley of Charles Schwab discussed the reasons for investing in foreign firms instead of U.S. multinationals in an article back in May. From the article titled “4 Mistakes to Avoid in International Investing“:

  • “The stocks of U.S. multinational companies tend to move in tandem with other U.S. stocks, and U.S. multinationals typically still derive a large percentage of their profits from the United States. But this misses the point of investing internationally—to diversify into areas that aren’t so highly correlated with the U.S. market.
  • Similarly, multinationals have a greater tendency to hedge currency exposure—and one reason to invest internationally is to increase your currency diversification, not reduce it.
  • U.S. multinationals may not do as well as local competitors in their target foreign markets due to cultural and local differences. After all, not everyone prefers U.S. brands, and some U.S. companies have difficulty customizing products for foreign markets.
  • The U.S. share of the global stock market is declining, so investing in U.S. multinationals means missing out on different opportunities elsewhere. When you look at global GDP, non-U.S. countries dominate, indicating the market share of these countries has room to grow.
  • Owning large multinational companies means excluding small cap companies that are more closely tied to the economic conditions in their local markets. International small cap stocks have even lower correlations to U.S stocks than large cap international stocks.”

Source: 4 Mistakes to Avoid in International Investing, Charles Schwab

In this post let us take a look at a chart I recently came across at The Big Picture related to this subject. Here is the chart:

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Source: MarketWatch via Barry

Investors must note that the above chart is not accurate in terms of data and is based on estimates. This is because many US firms including multinationals in the S&P 500 do not report sales by country and may group countries into regions as they wish. For example, instead of reporting sales by US, Canada and Mexico, they may just report it as sales in North America. Similarly they may combine sales in China with the figures for countries such as Taiwan, Hong Kong, etc. and call it ‘The Greater China’ region. 

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On the Importance of Dividends to Total Returns

Dividend stocks offer cushion to a portfolio during volatile market conditions such as the one we are seeing now while helping to grow the portfolio steadily when markets are strong. Investing in stocks that pay no dividends is highly risky since one is betting on pure price appreciation which may or may not happen. Studies have shown over and over again that dividend payers handily beat non-payers over time. Here is a chart that shows the importance of dividends to total returns based on the S&P 500:

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Dividends to total returns

Source: Case for dividend stocks now, Fidelity, 8/12/15

Winners And Losers Of Falling Commodity Prices

Lower crude oil prices benefit some countries while others suffer. Similarly cheap oil helps some sectors more strongly than others. For example, airlines and shipping firms benefit heavily as they are direct users of large amounts oil.

It is not just crude oil that has declined dramatically in the past few months. Other commodities such as palm oil, copper, iron ore, coffee beans, etc. have also plunged by substantial percentage points. The chart below shows the winner of lower commodity prices (not just crude oil): 

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Winners and losers of lower commodity prices

Source: Nomura Global Markets Research, October 2014 via Emerging market exodus by Maike Currie in Money Observer, Aug 20, 2015

Among the BRICs, Brazil and Russia are losers since both are big exporters of oil, iron ore, agricultural products, natural gas, etc. On the other hand, India and China are winners since both countries are net imports of oil and other commodities. Lower copper prices hurts Chile as the country is the largest exporter of copper in the world.

Lower commodity prices have a net zero impact on Mexico. Though Mexico is a big oil exporter, the Mexican economy also is well diversified with manufacturing and tourism being two other major sectors. So the negative effects of lower oil prices does not adversely impact Mexico than other such as Colombia, Venezuela or Russia.