How the Canadian economy – and stock market – can outperform – Financial Post

The Canadian economy is leading the G7 in terms of growth, so investors might be tempted to think this is as good as it gets. But there are several reasons why there more be more upside, and why Canadian equity markets may outperform.

Avery Shenfeld, chief economist at CIBC World Markets, noted that at almost three per cent, Canada’s real GDP growth for 2017 is quickly approaching an 18-year high. At the same time, the percentage of employed Canadians between 25 and 54 years old is near an all-time high, nearly every province is growing, and even the Bank of Canada sees a need to put the brakes on growth a bit.

Shenfeld highlighted that real GDP only accounts for what is sold at home and abroad, not the value on global markets. Canada can’t exchange oil or potash for as many imported consumer goods as it could before 2015, so real gross domestic income (a metric that incorporates that unfavourable trade relationships) has room to return to its previous trend level. As the economist put it, “We’re not quite as rich as we think.”

For investors, much of the focus is on how the impending monetary or fiscal policy tightening will affect earnings. Shenfeld doesn’t think this should be a concern, noting that U.S. growth has been half a per cent above potential at a time where real rates are negative.

But there is also the housing market to consider, as Canadian mortgages are not set for 30 years unlike the U.S. Therefore, higher rates will negatively impact household spending power.

The economist expects rate hikes in Canada will be milder than those in the U.S., as the BoC doesn’t want to risk bringing the loonie much higher to “growth-denting and inflation sapping” levels.

“U.S. equity multiples, particularly for domestically oriented firms, might therefore have to come down to earth as markets reduce expectations for earnings beyond 2018,” Shenfeld said, noting that S&P 500 companies with higher global exposure look like a better bet given that the benefit of a lower U.S. dollar.

“Recent loonie appreciation will work the other way for the near-term foreign earnings of TSX stocks,” he added.

However, Shenfeld highlighted the Canadian energy sector as a market segment where analysts have adjusted to the reality of lower oil prices.

“With progress on production costs, that could help Toronto outperform New York given energy stocks’ outsized weight north of the border, if as we expect, the Canadian dollar’s climb comes to an end soon,” he said.

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