An unusual thing happened in 2011 – at least unusual for the last decade. The US stock market outperformed the Canadian one. That makes twice since 2000. In the past twelve years, Canadians who kept their money here have done much better than those who bought US stocks. There are two reasons. Canadian stocks have been stronger performers on average than US ones over that period. The TSX is up 33.8% since Dec. 31, 2000. The S&P 500 is down 5.7%. But that’s only half the story. In 2000, the Canadian dollar was trading at 67.3 cents US. A Canadian investor had to pay $1.49 for every American dollar he or she invested in the US market. By the end of this year, the Canadian dollar was up to 98 cents US. On top of the dismal stock market performance, our unlucky investor had a currency loss of 48%. Put both factors together, and the S&P 500 had a negative return of 36.7% for the period for Canadian investors.
Our long time clients know that we have tended to stay close to home with our investments. We were worried about currency risk even after our dollar had climbed to the mid 80 cent level in 2005, and we believed that Canada’s markets provided ample opportunity without the need to worry about our currency continuing to appreciate. The question arises: is this the time for us to expand our investment horizons and buy more non-Canadian stocks? As always, there are arguments on both sides.
On the one hand, with our dollar close to par, it is hard to see much currency risk, certainly not as much as there was at 65 cents. As well, the U.S. market is arguably very cheap, particularly for the largest companies and there are sectors in the U.S. we simply do not have in Canada. Finally, continued low interest rates and slow growth in the world economy may argue against the Canadian markets which are so dominated by growth sensitive commodity stocks. Arguing against larger foreign holdings are the tax laws and the uncertain political and economic future of the U.S. and Europe.
Dividends make up a substantial portion of every investor’s total return, and dividends from Canadian companies get taxed at half the rate of dividends from non-Canadian ones. That’s a big difference over time, amounting to an after-tax differential of over 1.5% per year. All things being equal, a U.S. or European company will have to grow about 3% per year faster than its Canadian peer just to keep even on a total return basis.
Finally, we remain concerned that politicians in both the U.S. and Europe lack the resolve and hard-headedness needed to confront their debt crises which could cause massive economic upheaval. Canada, having dealt with its federal debt problems earlier than the other major industrial countries is a good place to be in times of stress, and our banking and financial system has proven to be robust.
On balance we think the arguments favour increased foreign holdings at this time, but we do not expect most portfolios to see non-Canadian stocks rise to above 15% of total equity allocations. The favourable tax, fiscal and political environment convince us that there’s still no place like home.