While the Bank of Canada worries about global uncertainty as it tries to gauge economic outlook, some investors worry trade tensions could push us into a recession. Bruce Cooper, Chief Investment Officer, TD Asset Management, talks to Kim Parlee about the challenges and opportunities for the Canadian equity market.
Welcome to the show. Great to have you with us tonight. In his last speech before the Bank of Canada decides whether or not to raise interest rates, Stephen Poloz warned that global uncertainty was making it difficult to gauge Canada's economic outlook. Here to help us sort through some of these comments and uncertainties, and what it means for the overall markets and the loonie, is Bruce Cooper. He is Chief Investment Officer at TD Asset Management.
So I want to start with-- the Bank of Canada came out today, and they said that they're factoring in all the uncertainties that are actually happening internationally and to our outlook. There's a lot of uncertainties right now. How do you navigate all this right now, because it seems like with a tweet about trade, everything changes?
Yeah, trade is at the top of the things we worry about. And it's been that way, really, since Donald Trump was elected. Really, as soon as he got elected, we said there's things the market is going to like. They're probably going to like tax cuts, particularly for corporations. They're going to like deregulation. But they're going to worry about trade and the fact that he seems to be anti-free trade.
And he's actually surrounded himself with people who are antagonistic to free trade. Think in particular of Peter Navarro and Robert Lighthizer. I think that's coming through. It's fascinating to see. Right now the US is in disputes on the trade front with Canada and Mexico and Europe and China. That's a pretty big list. So yeah, there is a lot to worry about, for sure.
Let me bring up-- and you put out a note recently, part of your foreign perspectives. So let's bring up a map that we have here. And this shows just the trade flows from a NAFTA standpoint, basically what's happening Canada, US, US-Mexico. Bottom line is there's a lot of trade going between all these countries. How concerned should we be? I think this is what the market's trying to gauge. You mentioned he's got trade disputes with almost every continent. But when does it become beyond just rhetoric to actually, OK, now we really actually have to worry how this hurts the markets?
Yeah, I think we have to worry already. But our base case shouldn't be a disaster, if I can kind of distinguish between those two things. I mean, there are real things that have happened. As we know, we already do have tariffs on steel and aluminum, for example. And on July 6, it is scheduled that tariffs are going to go on exports out of China and into the United States. So real things have happened. And then on top of that, there's been a lot of additional rhetoric.
But from a Canadian perspective, this is unsettling. Trade is exceptionally important to the Canadian economy. I tend to think that Canada has been a bit sideswiped, and the real target on the NAFTA side is Mexico. As we all know, if we can stick with the facts, the trade between Canada and the US is pretty broadly balanced. I think it's been an exceptionally healthy relationship between the two countries for decades and decades and continues to be.
So we should be in good shape. But we get a bit sideswiped by the focus on NAFTA, which stems from Mexico. And if it does come unraveled, I think it could be quite negative, for example, for the Canadian dollar.
And we're seeing that, I guess.
We're absolutely seeing that.
Yeah, the anticipation, I think, when you heard the Bank of Canada governor speaking today, and again every time someone speaks. But you see a little more uncertainty into whether those rate hikes would actually come. And then I guess the bonus for, I guess, the Canadian companies who are exporting, at least the lower dollar helps mitigate that.
Yeah. It's the natural release valve when this sort of uncertainty comes through. We also believe that the Canadian economy is weak relative to the US economy. We're absolutely not in recession. We continue to grow. But the US economy is going forward on all cylinders right now, and the growth is very strong. And Canada is a bit uneven. I tend to use the word lackluster. And because of that, I think the best guess would be that the Bank of Canada is going to raise more rates more slowly than the Fed, and that that tends to put pressure on the Canadian dollar, downward pressure on the Canadian dollar.
All right. When we come back, Bruce has just got a note out called The Great Canadian Uphill Battle. We're going to talk a bit about that in terms of markets, earnings, and what it means. You're watching Money Talk. We'll be right back.
Welcome back. We're here with Chief Investment Officer for TD Asset Management, also CEO of TD Asset Management. We were alluding, or talking or moving into talk about Canada and the markets. And again, there's-- lackluster, I think, was your words in terms of what's happening here.
You talked about the Great Canadian Uphill Battle. We've got a chart here again that we're showing, which is Canadian equity performance, I think from 2017 till now. And again, I think this is about the timing that you guys made a call that you weren't loving Canadian markets.
Yeah, we got a bit cautious on Canada a little over a year ago. I think it was actually in March of last year. We had a number of concerns. And we just put out a note where we really wanted to revisit that position. How do we feel about it? Obviously Canada has underperformed by quite a bit in the last year or so relative to both US and international stocks.
And the conclusion I'm sure we'll talk about is we continue to be a little on the cautious side with respect to Canada.
And for people who are looking at this chart, it's the green line in the bottom, just to let you know, is the returns that were-- the growth of $100 from March 2017 to April 2018. So yeah, we're on the bottom there.
The next chart, though, I actually think is pretty telling as well, is this is a look at Canadian earnings and have materially underperformed US over the last 10 years. So not a big surprise. If we were to layer on the TSX and the S&P 500, it'd be really similar, wouldn't it?
Yeah, that's it. You know, over long periods of time stocks tend to follow earnings. I mean, as an equity owner, you own the business, you would expect that if the earnings grow over long periods of time, you'll do well. And that's certainly what's happened.
And in the United States, you've had great earnings growth over the last 10 years despite-- you had thee financial crisis early on there, and since then, you've had a great recovery, in a lot of cases driven by technology, which is the largest weight in the S&P 500 today. And we know that's where a lot of the innovation in the economy is occurring, and where tremendous earnings growth has taken place. You also have things like health care in the United States, which have likewise done very, very well.
In Canada, we continue to have big weights in things like energy and materials, and the last 10 years has been a pretty tough environment. In fact, earnings in those sectors have actually gone down over that full 10-year period. And so part of the reason that Canada has lagged is just simply the sector composition. And when we look at it, technology continues to be an exceptionally important part of the economy. And for Canadian investors, if they want exposure to tech, in a lot of cases, they need to invest south of the border. That's an important theme that runs through portfolios.
So moving ahead, then, again, materials have underperformed when it comes to earnings, energy's underperformed, financials have done OK. But if you kind of look at those three big chunks of, really, what make up the TSX moving ahead, how's it looking?
Well, when we think top down, first of all, I talked about the fact the Canadian economy is a little on the lackluster side. And so for domestically facing businesses in Canada, I think it's going to be a bit of a tough grind. Financials, to some extent, do fall into that category. We do think banks are tremendous businesses and can continue to grind out good earnings growth, but probably a little slower in the next three to five years than they have in the last 10. So I think that's a challenge.
Look at other areas like pipelines. That's been a big overhang in the Canadian market. Politically, it's been tough to get new pipelines built, as we all know. That has an impact both on economic growth, but it's also had an impact, I think, on the way both domestic and foreign investors view that sector. And pipeline stocks have been rather poor performers of late.
It's tough with the Canadian market, given you're so heavily weighted in those three. Is there any opportunity, though, with-- take a look at the energy stocks. Oil has been trending up. When it gets up to 80, we really start to see some torquing in the Canadian names.
So for sure, Canadian energy stocks, the producers have lagged. And we would think that there's an opportunity in what we would think of as the high quality producers. You think about things like Suncor, Canadian Natural. These are companies that have, in recent years, actually driven their costs down quite a lot. And where oil is today, $65, $70, it's been trading around there-- obviously a bit of a discount for Canadian oil-- but at those prices, companies like Suncor and Canadian Natural are actually able to generate very significant free cash flow.
And so we think there's opportunity in the high quality companies. We prefer to shy away from the lower quality, higher cost producers that, if oil went down $10, they're going to be in big trouble. But you know, that's where we think there might be some opportunities.
Last question for you. I know one thing that--and we don't have the chart here to show people. But I know I was chatting with you and some other people earlier today and we were looking at valuations on the TSX as compared to, say, other indices. And one thing that was really interesting is that the value of the companies in TSX is really driven mostly by earnings. And we're not seeing PE multiples on Canadian stocks.
In the United States over the last 10 years or so, we've seen valuations go up. I think part of that's because earnings growth has been good.
And multiple expansion.
Technology has taken on a bigger weight, they tend to be higher multiple stocks. And so the multiple for the whole market has increased. In Canada, if you think about those big sectors that you referred to earlier, banks, you know, I think they are very good businesses, but they tend to always trade around 11 times earnings. Energy stocks are not high multiple stocks. So you're right. You have not seen multiple expansion in Canada, partly because the fundamentals for the corporate sector have not been that great.
Last question, really the last question, since I said the last one was. But just in terms of-- for those of us who are kind of sitting and watching with bated breath when every tweet comes out. What are you watching? What's material for you to watch right now?
So our base case is still that we get resolution of these trading issues. I think President Trump and the US administration, they are trying to push China around some legitimate issues with respect to technology, concerns around patents and intellectual capital. So you got a bit of a tug of war going on between the giants of the global economy. I think we'll just have to see how that plays out. I think it's going to be long lasting, but doesn't mean there's going to be sort of dramatic fights. I think it could be just a little skirmishes that play out over long periods of time.
In the meantime, the US economy is actually in great shape. We haven't talked about that much tonight, but the US economy is in great shape. So underneath the surface, for high quality businesses, there's still the opportunity to grow earnings and grow cash flow and grow dividends and all that great stuff that we look for over time.
Bruce. Always a pleasure. Thanks so much.
Great to be here.
Bruce Cooper, Chief Investment Officer and Chief Executive Officer of TD Management joining me here in studio.