From 2004 to 2010 the TSX 300 Index of leading Canadian stocks outperformed the S&P 500 Index of major American companies in each and every year. Canadian investors did much better than their American counterparts, and to add icing to the cake, the Canadian dollar rose steadily from about 78 cents US in 2004 to over par in 2010. It was a great time to be in Canadian stocks. Nothing lasts forever, as we all know, and things changed in 2011. The TSX had a poor year, falling 11%, while the S&P 500 was flat. That trend has continued in the first half of 2012. The TSX was down 3% for the six months ended June 30, while the S&P 500 rose about 8%.
The biggest winners in the US so far this year were in the technology area, a sector which has almost disappeared from the Canadian market with the diminishment of Research in Motion. Apple became the most valuable company in the world and giants such as Oracle, Microsoft and IBM did very well, driving up stock prices and the index. In contrast, the Canadian market was dragged down by its biggest sectors, the materials and energy industries. Prices for most industrial commodities such as oil, gas, iron, and zinc fell due to concerns over lagging economic growth. The prospect of recession in Europe, a faltering US recovery and slower imports from China and India had a significant impact on these already volatile sectors. Not surprisingly, the Canadian dollar slipped under par.
During the recession the Canadian dollar collapsed to about 75 cents US. At that time we sold all of our US stocks and converted the proceeds into Canadian dollars. Starting in 2010, with the Canadian dollar back above par, we began re-investing in the US markets. Most of our clients now have a significant portion of their equity holdings in major US companies, and this is a tread which we expect will continue.
Here is a look at how the major stock market sectors have performed for the first six months of 2012.
Financials. The major Canadian banks had generally strong earnings for the first half of the year, but were unable to make any progress due to concerns over Europe and sovereign debt. Our major holdings (National Bank, Royal Bank and Bank of Nova Scotia) were up slightly for the period. We continue to be bullish on these banks, which have an average dividend yield over 4% and an average price to earnings ratio of only 10 times our expected 2013 earnings, compared to a more normal ratio of about 12 times. Insurance companies continue to face heavy head winds due to very low bond yields and we do not expect to increase our exposure to this area.
Utilities. The utility stocks had a mixed performance. Investors have bid up prices for these companies in their search for high dividends, bringing yields down to the 3.5% range, and raising price to earnings ratios to the 16 times our expected 2013 earnings level. We do not expect to see major movement in this sector during the balance of the year since interest rates will be kept low by the central banks. This will continue to be a safe haven area for those seeking yield and downside protection.
Industrials. Our experience in this sector was generally positive in the first half, with Methanex gaining 18%, Algoma Central up 10% and CSX up 5%. However, problems at SNC–Lavalin’s north African operations caused a major drop in that stock, which is recovering slowly. With the Canadian dollar under par and signs of increased activity in the US auto and housing sectors, we expect to see some progress for Canadian industrial companies in the second half of the year. Many companies have been raising their dividends and most have very strong balance sheets, giving an unusually high measure of resilience to stock prices.
Real Estate. As with the utility sector, prices for real estate stocks have been bid up by those seeking yield, making this our best performing area. Morguard, Brookfield Asset Management and H&R REIT all had very solid returns. Payouts in the 5% to 6% range are still available, making this a key sector for conservative income seekers. However, we do not expect much upward price movement for most stocks in the second half of the year as companies find themselves paying high prices for new assets. High prices for newly purchased real estate means lower returns on equity for the buying companies, and this will impact their ability to raise payouts to shareholders in the future.
Consumer Goods. Food companies did particularly well, with High Liner Foods, Tim Hortons, Saputo and Rogers Sugar outperforming the market. Major retailers such as Empire Group (Sobeys) and Shoppers Drug Mart were flat. Companies in this group are generally trading at moderate price to earnings ratios and pay moderate dividends. This continues to be an area we believe will do well due to its relatively low exposure to macroeconomic news and high stability.
Telecom. The arrival of new entrants in the cellular market has, as expected, depressed margins and raised marketing costs for the entrenched players, and as a result the stocks as a group were flat for the first half. Nonetheless, dividend payouts remain very attractive in the 4.5% area and price to earnings ratios are modest in the 12 to 13 times our expected 2013 earnings range. We expect to see some modest price appreciation. Moves by companies to charge consumers for increased use of bandwidth on mobile devices have potential to restore margins to previous levels, but face consumer backlash.
Materials. Concerns about slowing growth in Asia and recession in Europe have kept commodity prices in check. These stocks did poorly as a group in the first half and remain volatile. Gold and silver seem to have lost their status as investment havens in uncertain times, and the stocks of precious metals miners have done particularly badly. We have eliminated our holdings in precious metals and limited our positions in other commodities. We expect continued volatility in reaction to developing macroeconomic events around the world.
Energy. Oil prices fell about 20% in the first half of the year, and natural gas was worse. Not surprisingly most stocks in this sector struggled, with CNQ down over 20%. Our other holdings in the sector were flat. As with other commodity prices, we expect high volatility in the energy area, and we are not planning any new investment in the industry at this time.
Technology. Our two major holdings in this sector did well in the first half, with Apple rising over 40% and Microsoft up about 20%. We see the potential for further gains as companies are flush with cash and can raise dividends and make major stock buybacks. Most of the larger companies trade at modest price to earnings ratios on an historic basis.
Fixed Income. US and Canadian bonds are now trading at record low interest rates for almost all maturities out to thirty years. With central bankers around the world pledged to keep rates low for at least the next two years, there is little immediate risk that the bond market will collapse. However, the medium and longer term risk to bond portfolios with long maturities is extremely high. We continue to restrict our purchases to shorter dated bonds and retractable preferred shares. Corporate issues continue to offer reasonable spreads over Government bonds.
The post-recession stock market started in late March, 2009, and is therefore now about 38 months old. The initial gains were rapid, with the S&P rising 100% in two years, and the TSX gaining 92% in the same time period. Since March, 2011, things have been tougher, and the TSX has fallen over 2,500 points or 18% from its peak of 14,329 in that month. The S&P 500 has been pretty much unchanged. Making money has been hard for the last year and a half, but we are pleased to see that the great majority of our clients have positive returns for the first half of 2012. We hope to add to these gains in the rest of the year.