January 17, 2014

The patience of Canadian stock market investors is being tested (Part 2)

Continued from Economy at a Glance Part 1.

There is a similar story of price restraint in other commodity sub-sectors.

The Bank of Canada’s metals and minerals (gold, silver, nickel, copper, aluminum, zinc, potash, lead and iron) price index rose to a new peak after the recession, but it has since fallen by 30%.

One only has to consider the track record of gold prices (plunging from $1,900 U.S. per ounce at its most expensive to $1,250 now) to appreciate some of the negative turnaround.

Potash prices have also fared badly, as the result of a Russian-Belarus cartel collapse.

Agricultural prices (cattle, hogs, wheat, barley, canola, corn and potatoes) are also below both their pre- and post-recession peaks. Over the past year, they’ve fallen by about one-third.

Only forestry-related commodities (lumber, pulp and newsprint) are showing a more spirited response to present economic circumstances.

The dramatic improvement in U.S. new home starts has lifted the BOC’s forestry products sub-index by 69% from its trough level in early 2009.

At both the beginning and end of 2013 — with a temporary retreat in the middle of the year — the forestry commodities price index climbed above its previous most notable spike in early 2004.

Perhaps the best way to summarize the equities picture north of the border is to say that the patience of Canadian stock market investors is being tested.

We should keep in mind, however, that by comparison with some other countries, our financial landscape isn’t nearly so gloomy. Japan immediately comes to mind.

In December 1989, Japan’s Nikkei 225 index crested just below a level of 39,000. Over the next 13 years, it tumbled down a steep slope, bottoming out at 7,973 (-80%) in March 2003.

During most of the ensuing 10 years, the Nikkei 225 trolled the bottom.

Finally, last year, the Nikkei served up a reward worth celebrating. December’s closing was +57% year-over-year.

At its most recent level of 16,291, however, the Nikkei 225 is still less than 50% of its all-time best.

Elsewhere among major stock market indices, London’s FTSE 100 was +14% year-over-year on December 31 2013; Germany’s DAX 30, +25.5%; and Hong Kong’s Hang Seng, only +2.9%.

By the way, here’s an intriguing observation concerning bubbles and what happens when they burst.

It may be coincidence, but two of the most horrendous economic collapses in recent memory — Japanese stock prices as captured by the Nikkei index (1990 through 2002) and U.S. housing starts measured in annualized units (2006 through 2008) — featured identical drops of 80%.

What can we expect from the TSX as 2014 passes from infancy into adulthood?

The Federal Reserve and the Bank of Canada have committed to keeping their policy-setting rates at record lows throughout the year.

But the Fed’s “tapering” of bond purchases will launch an upward climb in some public and private sector yields.

An anticipated drop in bond prices (i.e., the selling price falls as the rate rises) will cause many investors to switch their holdings from fixed income securities to stocks.

Not all investors will take this path. Some will appreciate the fact they can move money into safer “notes” generating higher yields.

The Fed’s decision to “taper” expresses confidence that the U.S. economy is on a sound expansion path. Many recent statistics — on employment growth, the jobless rate, home prices, etc. — have become decidedly upbeat.

Economic leadership by the U.S. economy will bestow benefits on Canada, particularly through improved export sales.

The recent decline in value of the Canadian dollar versus the greenback will also help generate more contracts with customers south of the border.

Plus it will boost the revenue and profits of domestic producers who sell their products with a U.S.-denominated price (i.e., most commodities).

Rather than just another stodgy year for the TSX, there appears to be more upside potential than there has been in a good long while.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog.

Commodity price index
(as calculated by the Bank of Canada)

The total commodities price index is comprised of products in energy, metals and minerals, forestry, agriculture and the fisheries.

Data source: Bank of Canada. Chart: Reed Construction Data - CanaData.

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