This year North America is playing a leading role in sustaining the recovery of the global economy. While the US economy experienced a relatively weak patch in the first quarter, with GDP growth likely easing to about a 2.5% annual rate, following a robust 3.1% in the final quarter of 2010, leading indicators suggest the pace will pick up in the remaining three quarters of 2011. The Canadian economy had a strong January (Canada publishes monthly GDP numbers) and may well have matched in the first quarter the 3.5% annual growth rate achieved in the final quarter of 2010. Forward-looking indicators for capital investment plans and export orders imply continued strength in coming months.
We believe there are several reasons to overweight Canada in our International and Global equity portfolios this year. Thus far this year the Canadian equity market has been performing strongly. Looking at the MSCI total-return equity indices, Canada is up 9.30% year-to-date (April 4th), compared with 6.57% for the US and 4.57% for the advanced markets outside of North America. There are two good Canadian ETFs with sufficient liquidity: the iShares MSCI Canadian Index Fund, EWC, which is up 9.68% thus far this year, and the Guggenheim Funds Canadian Energy Income Fund, ENY, which is up 15.09%. The first, EWC, tracks the total Canadian equity market, and the second, ENY, tracks the “Sustainable Canadian Energy Income Index.”
The first two reasons for being attracted to the Canadian equity market at this time are the close connection of the Canadian economy to the solid growth of the US economy, and the significance in Canada of the energy, raw materials, and agricultural sectors. These sectors are profiting from the global economic recovery, with the energy sector also benefiting from supply uncertainties due to conflicts in the Middle East and Africa. My colleague David Kotok has explained in his recent Commentaries why we are overweighting energy in our various portfolios. The two Canadian ETFs listed above can be considered in part energy plays. The ETF, ENY, is totally focused on the Canadian energy sector. In the case of EWC, firms in the energy sector account for 27.7% of the covered listed firms. The materials sector accounts for another 21.9%. The financial sector is also important, accounting for 31.33%. Firms in the Canadian financial sector were not as severely affected by the recent global financial crisis as those in the US and Europe.
A third reason for overweighting Canada is the ongoing strength of the Canadian dollar. The Canadian dollar ETF, the CurrencyShares Canadian Dollar Trust, FXC, is up 3.25% so far this year. For the US investor, a stronger Canadian currency vis-à-vis the US dollar translates directly into higher US dollar returns from Canadian investments. One factor that may continue to strengthen the Canadian dollar is the prospect that the Canadian Central Bank will increase short-term interest rates in the second half of this year, whereas it is unlikely that our central bank, the Federal Reserve, will move that early.
