Home (not so) Sweet Home
In 1989 Peter Lynch, the manager of the fabulously successful Magellan mutual fund wrote a book called “One Up on Wall Street”. The book has never gone out of print and is most famous for one piece of advice: “Buy what you know.” Rather than relying only on traditional financial statement-based analysis, Lynch would go out into the world and observe how people acted, what they bought, and how manufacturers and retailers met their needs. If a particular brand seemed to be doing very well, take a look at the stock. If a car dealer’s show room was full of stale inventory, run away. This commonsense approach is still in vogue, and the book is still a big seller.
One thing everyone knows pretty well is their home turf. We Canadians bank with one of the big six, buy our groceries from one of the four major grocery chains and fly on one of two airlines. We get our cellphones from one of three providers and should we need to ship goods, choose from one of our two railways. Since we know these companies so well, we tend to invest in them. In this, we are not unique. Every country exhibits home market bias, as the chart below shows. The Canadian equity market makes up about 3.4% of all world equities, but the average Canadian has 52.2% of their equities invested here.
Sometimes this bias works in our favour. From August 2004 to June 2008, the TSX rose 84% as oil hit an all-time high near $150/barrel. During the same period, the S&P 500 rose a relatively anemic 24%. However, this period of out-performance has not been repeated in the 15 years since the end of the great economic downturn. From 2008 to today, the S&P has gained an astonishing 391% while the TSX has gone up only 46%. Home bias has cost Canadians investors a huge amount of money that they would have made had they owned more non-Canadian stocks.
There are three main reasons for the under-performance of the Canadian equity markets:
Scale: Even our biggest companies are small in global terms. The TSX has two companies with market capitalization of over US$100 billion and 14 with capitalization over US$50 billion. In world markets there are now 7 companies worth more than US$1 trillion, 15 worth more than US$500 billion and 40 worth more than $250 billion. Our market champions are hometown heroes but in world terms, they are in the little league.
Sectors: All our biggest companies are clustered in three sectors: finance, energy, and materials. We are hugely under-weight in the two most important growth areas: technology and healthcare. Just think about artificial intelligence and the semaglutide drugs like Ozempic. These are themes which are not available to Canada-only investors.
A Market Backwater: For world investors, the Canadian stock market and the Canadian dollar are barely on the radar. As investors’ funds become more and more concentrated in giant exchange traded funds (ETFs), the major markets will tend to get even larger over time. We have seen this particularly in the U.S. with the sudden emergence of companies worth as much as US$ 3 trillion, which is more than the cumulative value of all companies listed on the TSX.
Despite these three major negative factors, there are at least two reasons for Canadians to own some Canadian stocks. Dividends from Canadian companies get preferred tax treatment. The difference between a 39% tax on Canadian dividends and a 52% tax on foreign dividends is significant for income-seeking investors. The other reason is currency risk. Owners of foreign equities are at the mercy of unpredictable exchange rates, mostly for the US$ against the CDN$. This works in favour of an investor in non-Canadian stocks when the Loonie goes down, but when it is on the rise, the value of the foreign stocks go down. This was most evident in the period from 2002 to 2011 when the CDN$ rose from US$.64 to US$1.02. Holders of US stocks saw their value, measured in Canadian dollars, fall by 37%. Nobody can predict if or when that might happen again. Since Canadians pay their bills (and taxes) in Canadian dollars, this is a real risk that cannot be ignored.
At Baskin Wealth Management we have been moving more and more of our equity holdings to non-Canadian stocks over time. This is one reason our equity heavy portfolios have done much better than the TSX index. We will always be investors in Canadian stocks, and some of them have done very well for us (to name a few, TFII, Constellation Software and Brookfield Asset Management), but we are reducing our home bias, and this is a trend that will continue.
Chairman
David Baskin
Blog
Fun with numbers – should you realize capital gains and pay taxes early? – David Baskin
An Ernest Opinion by Ernest Wong
What I’m watching from first quarter earnings – May 1, 2024
Media Appearances
Barry Schwartz on BNN’s Market Call – April 9, 2024
Ernest Wong on BNN Bloomberg’s The Street: We remain underweight on Canadian stocks – April 11, 2024
Barry Schwartz interviewed by StockPick New – April 26, 2024
Long Term Investing podcast
Compounding is afoot at the Circle K – April 1, 2024
April Financial Planning Edition – All about Trusts – April 9, 2024
The Canadian Compounder discount – April 15, 2024
Trash is Cash: Waste Connections – April 22, 2024
Special Financial Planning Episode on Capital Gains – April 29, 2024
Interesting Reads
What are the chances? – Nautilus
Blame the Ancient Egyptians for taxes – Smithsonian Magazine
