Canada's stock market is like the canary in the coal mine!

Today the world economy is clearly on the path of recovery. Economic numbers from both Europe and China, especially when combined with those in the U.S. support this. Yet Canadian investors have yet to benefit. While the U.S. stock market is clearly in bull market mode and with Europe’s stocks also ahead, here in Canada we seem to live in perpetual malaise.

In general terms, we can predict the cyclicity of stock markets and it can be roughly subdivided in five (5) stages:

1.       Crash – accompanied by emotions of denial evolving into desperation

2.       Bottom and initial recovery – Desperation combined with Value Investor heaven.

3.       Recovery – at this point only Value Investors and ‘Buy & Hold’ investors are in the market (this is where we are in Europe and Asia).

4.       Advanced recovery – the easy gains have been made and the general investor public returns to buy stocks (that is where we are right now in the U.S.).

5.       Euphoria – Everybody feels like a genius ‘the market can only go up’; ‘New economy’ – time to take profits and build up ‘cash for the coming crash’.

So where does Canada fit?  In spite of all the talk about globalization, not all local economies are created equal. The U.S. is a service and manufacturing economy predominantly and lately it has become more diversified due to the energy revolution and commodities are becoming more important.  But rather than hoping for higher commodity prices, the overall U.S. economy benefits from cheap commodity prices (low natural gas and oil prices in particular).   Although they produce commodities, farming (grains, vegetables, and fruit) and to a lesser degree ranching (cattle and other livestock) also benefit from cheap potash and energy prices.

Europe’s economy is another commodity consuming economy that is weighted towards services and manufacturing. Europe also does best when commodities and interest rates are low. Now that it has put some Band-Aids on its credit markets Europe is clearly recovering.

China and some other emerging economies are, in spite of their huge populations, strictly manufacturing and exporting economies. They need consumer demand from the rest of the world AND low commodity prices. Although gradually turning into consumer economies like the west, these emerging economies are still heavily dependent on growing demand from Europe and the U.S. whom together constitute close to 50% of the world economy – especially when you include Japan!

Only when the manufacturing and export economies do well will demand for commodities increase. Canada did great coming out of the 2008 financial crises but stock markets overshot economic reality in 2011 when the TSX reached a peak of 14,000. I warned in this blog that we had moved too fast based on my rough estimate that our market is likely approaching ‘crash territory’ at a TSX of 18,000 to 19,000 and that a TSX at 14,000 was way too early in the stock market cycle.

Canada was rewarded with a relative mild recession in 2008 thanks to our great fiscal position at the time – budget surpluses and acceptable government debt levels. We also had the strongest banking sector in the world.  But elsewhere the financial crisis did hit much harder and demand for commodities crashed. That is why Canadian markets have flattened in performance since 2011.  Our banks were fully valued. But other financials such as insurance companies (Great West Life, Manulife, etc.) were suffering because of artificially low interest rates and poor stock markets.  And the resource industry… just went into shambles. In particular gas which not only suffered declining demand but also the ‘benefits’ of the new energy revolution. It is a wonder that oil prices haven’t collapsed like natural gas. Just imagine what oil prices could be if the world economies are running full tilt!  

I still think that for good world economic growth not only interest rates determine how well we’re doing; energy pricing is nearly as important, or if you a follower of Jeff Rubin energy prices are MORE important than interest rates.  On this blog we feel that oil prices of $125 or higher will destroy economic growth – in the future this price cap is likely to go up with worldwide inflation.

But just like, as described in an earlier blog, the Chinese and other emerging economies cannot do well when Europe and the U.S. aren’t; Canada with its dependence on the resource industry needs all three big economies to do well. Canada does well in the last stage of the world’s business cycle.

I think the statement that the 21^st century belongs to China is greatly exaggerated. That country has tremendous problems to overcome.  Europe, the U.S. and of course Japan are hard to beat. But we need prosperity in all these economies before Canada (and Australia) will fire on all four cylinders. When this happens, let your Canadian profits run but use trailing stop losses because the world will be close to a crash – my guess is that we’ll be there in 2016 and that 2014 and 2015 will be terrific years for Canada.

For now, my investment emphasis lies on the U.S. and I have diversified a bit Europe.  Investing in the raw stock markets of emerging companies is too much for my stomach. I wish those who venture their all the luck.

So Canada is a bit of the 'Canary in the coal mine'. When Canada’s stock markets are booming and oil prices hover around $125 per barrel then hold on to your hat because the crash is coming near.