There are five main drivers of the Canadian equity market right now, says Paul Taylor, chief investment officer, asset allocation, with BMO Global Asset Management.
The biggest of the five is the price of oil. "Oil is definitely the trump card on the current market," says Taylor. "Low oil prices have a negative dampening effect on Canadian economic activity and that just simply reflects that we're still a trees-and-rock-based economy."
The most direct impact of oil prices is probably on corporate earnings, Taylor says. He estimates that 21% of the Canadian market is directly related to energy. With the price of commodities down by approximately 50% from last summer, there has been a very negative impact on corporate earnings.
Taylor's choice as the second key driver is the financial health of Canadian consumers, including their heavy debt load. Canadians have taken advantage of generationally low interest rates to buy assets, especially real estate, stretching their personal balance sheets. "The level of indebtedness in Canada is close to where the U.S. was prior to the great financial crisis," says Taylor. "So that is an issue for the Canadian equity markets and the Canadian economy."
A third key driver for Canada, says Taylor, is the strength of the U.S. economy. Its weakness in the first quarter has had negative repercussions for Canada. "Simply put, the old adage: when the U.S. sneezes, we catch a cold. And that applies in this situation as well."
The fourth driver to watch, says Taylor, is the movement of the Canadian dollar, which is closely tied to the price of oil. "We've moved from US$87 cents to US$77 cents, then back to US$83 cents and are now hovering around the USS80-cent mark," says Taylor. If a country is less competitive, "as we are here in Canada," the further the currency falls, the more that tends to make you more competitive on the world markets. "The big winners are those who sell in the U.S. and produce in Canada," Taylor adds.
The fifth key driver, says Taylor, is the influence of China. Canada remains largely a resources-based economy, and global commodity prices are very sensitive to the pace of Chinese economic growth. China's slowdown from a growth rate of 8% to 10% or more in recent years, down to probably below 7%, has been a source of weakness in base and precious-metals prices and energy prices, Taylor says.
Taylor has emphasized non-resource sectors in the domestic equity portion of BMO Asset Allocation, one of the multi-asset-class mandates that he manages.
Current holdings include Canadian Pacific Railway Ltd. (CP). Given the size of the company and its existing railway network, says Taylor, there are significant barriers to entry by competitors. He says CP has "extremely deep tentacles in the Canadian economy" and very strong relationships with existing customers and potential customers. "So I think that's an example of the quality, and there's also some growth potential because it's tied to the growth of the economy and reasonable valuations."
Among Taylor's defensive holdings is Dollarama Inc. (DOL), which he considers to be the pre-eminent dollar-store experience for Canadians from coast to coast. "It's got some nice defensive characteristics," says Taylor. "It is counter-cyclical. When the economy stalls, customers may forgo ski trips to Whistler, but they will still pop in to a Dollarama for purchases. We bought it when it went public about seven years ago at $17.50 and it's now trading at $70."
Looking ahead, Taylor believes some of the major headwinds that the Canadian economy faces aren't expected to shift quickly. He thinks oil prices, for example, will remain somewhat depressed for some time.
"We also feel that the debt of the Canadian consumer is something that we will have to deal with over a period of time," says Taylor. "So we think we'll struggle a bit here in Canada to deliver the top line of economic growth and earnings growth that we'd like to see support significantly higher equity prices."
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