The world today is a global village, and investors have many options to geographically diversify their investments. Canada, one of the wealthiest countries, is also one of the safest places to invest. The country has abundant natural resources with a strong service sector backing the economy. The Toronto Stock Exchange (TSX) has been one of the best-performing markets in the world with companies that provide steady growth in an environment of economic and political stability.
*YTD returns through July 20, 2014. Source: TSX
- Richness in Natural Resources
Canada has a rich natural-resources base ranging from metals to oil and gas to agricultural resources. Those natural resources are a crucial factor in Canada’s economy and have brought growth, jobs and progress to the country. The natural-resources sector employs approximately 10% of the population.
The country ranks among the top-three global producers for potash (first), uranium (second) and aluminum (third). An extensive natural-resource base has helped keep Canada’s dependence on such imports low; while on the other hand, it has boosted its exports, improving its trade balance. According to the recent data, the natural-resources sector has a positive trade balance of $103 billion, while the rest of the economy has a negative trade balance of $106.5 billion (Facts & Figures: Natural Resources Canada).
According to the International Energy Agency, global demand for energy will increase 33% by 2035, out of which a 90% demand increase is expected to come from non-OECD countries. This will give Canada a chance to move beyond its traditional export markets. Canada is behind Venezuela and Saudi Arabia in terms of largest oil reserves in the world (173 billion barrels).
Over the next 10 years, the Canadian government will invest approximately $650 billion in major resource projects (energy, minerals, metals and forests), which will boost the companies operating in these and related sectors.
- Banking System
Canadian banks have been singled out as the soundest in the world by the World Economic Forum in its global competitiveness reports for the past six years in a row. The Canadian banking system showed great stability and strength even during the 2008 financial crisis that rocked the banking system across the West. Canadian banks have beaten their U.S. counterparts in terms of consistently strong returns on equity (ROE) and total shareholder returns (TSR). A major contributor to this outperformance has been the fact that the Canadian banks did not experience the large-scale write-offs that almost all U.S. banks had to do. The major banks in Canada have witnessed a year-on-year rise in revenue that has led the Big Six's profits to exceed a combined CA$30 billion. Big Six includes the National Bank of Canada (TSX: NA), The Bank of Montreal (TSX: BMO), Royal Bank of Canada (TSX: RY), Canadian Imperial Bank of Commerce (TSX: CM), The Bank of Nova Scotia (TSX: BNS) and Toronto-Dominion Bank (TSX: TD).
Many Canadian companies are known for paying dividends at higher rates than companies in other countries. Dividend-paying stocks are a good bet, as they are usually less volatile and offer regular income in the form of dividends along with long-term appreciation. The leading dividend payers are large and mature companies from energy, financial and telecommunications sectors.
The inflation rate in Canada has been tamed under 3% over the last 10 years with an exception of a few months in 2008 and 2011, when inflation rose 3% but stayed under 3.5%. The Bank of Canada aims to maintain inflation at around 2%, which is the midpoint of its target range of 1-3%. The Bank of Canada aims to maintain predictable, low and stable inflation rates to create an atmosphere for sound economic growth and job creation.
- Alternative to Emerging Markets
Stock bought directly on the Toronto Stock Exchange gives investors an opportunity to diversify into markets other than U.S. and Europe, yet in a mature economy. Many investors also may be apprehensive to put their money into emerging markets, and Canada can be a good alternative for diversifying their portfolios.
A politically stable environment also makes Canada attractive. It is not only politically stable but has many economic indicators in its favor. The country has a moderate budget deficit compared to its peers. The balance of payments is small with a sound monetary policy.
- Tagged to the U.S.
Canada not only has the longest common borders with the U.S. in the world, but the Canadian economy also has a strong correlation with the U.S. economy, as the U.S. is its largest trading partner. This is likely to dilute the diversification factor that investors may be looking at while investing in Canada. Though Canada is working to decrease its reliance on the U.S. by signing new trade agreements and exploring more export destinations, it will take time for effect such changes.
- Commodity Price Volatility
The natural-resources sector contributes approximately 17-18% of the Canadian GDP. The prices for natural resource products (metals, minerals, etc.) are much more during times of economic prosperity, while they dip during periods of economic gloom. Since a majority of the Canadian stocks represent these sectors, they tend to be cyclical in terms of performance.
- Limited Choice
The TSX does not offer much variety beyond stocks from the energy, mining and financial sectors. There are only a few good stocks from the telecom and utilities sectors for investors to choose from. The stocks from sectors like technology and health care are poorly represented. This makes the exchange's movement biased as few sectors play a dominant role.
The Bottom Line
Investing in Canada is a good choice for picking stocks from sectors such as energy, financial and mining, as the Toronto Stock Exchange offers a wide range of such companies. Remember to follow Benjamin Graham’s principle: Look for undervalued stocks, as they will have more growth potential. TSX is currently 12% above its 2013 closing trading at around 15,000 levels. It will be wise to wait for the right dips to enter the markets to construct a portfolio with Canadian stocks. Investments in these markets add a flavor of fundamentally strong, dividend-yielding stocks from select sectors.