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Adrian Mastracci, investment counsel at Vancouver’s ‘fee-only’ KCM Wealth Management, says, "Most people who have invested heavily in the U.S. market since [2000] have experienced losses.” |
By Gail El Baroudi
Special to The Globe and Mail
Report on Business
Thursday, May 18, 2006
Despite its troubles, the American economy is surprisingly buoyant. But investors should watch the price of oil. And the housing bubble. And the exchange rate.
It's been a rough ride for Canadian investors in the U.S. market these past few years. Recently the picture brightened, with the Dow Jones Industrial Average struggling toward, but not quite reaching, the high ground it occupied six years ago.
No surprise it's been a struggle, however, with the Dow creeping up the proverbial "wall of worry" -- and some of those worries are formidable. They include crippling U.S. deficits, Middle Eastern forays that threaten to become boondoggles, high housing prices and an apparent loss of the American people's confidence in the Bush administration.
But through all this the economy is humming along, says Michael Graham, chairman of Heathbridge Capital Management Ltd., a Toronto-based investment counselling firm. "I use the term irrepressible -- you can't keep it down," he says.
Don't sell the United States short, he advises. "Its annual GDP in 2005 grew by 3.5 per cent, and although growth tailed off in the fourth quarter, it put on a burst of speed in the first quarter of 2006, with an astonishing annual increase of 4.8 per cent."
Corporate earnings are growing at a faster rate than they have in the past five years, Mr. Graham says, and the average price-to-earnings multiple on the S&P 500 is around 16 -- so stocks are not necessarily bargains, but not expensive, either. Historically, the index is low-priced at 10 or 11, and expensive around 20.
On a fundamental price-to-earnings basis, there are bargains to be found. The U.S. stock market is less expensive than the Canadian market and probably one of the cheapest in the world, says Stephen Jarislowski, chairman of Montreal-based Jarislowsky Fraser Ltd. "We are invested in stocks there that people don't like, large corporations that can't be manipulated, like Procter & Gamble."
In spite of its daunting problems, the U.S. economy has proved to be much stronger than anyone realized, says Peter Brieger, chairman and chief executive officer of GlobeInvest Capital Management in Toronto.
Even so, the United States certainly hasn't been an investment paradise for Canadians in the past six years. In January, 2000, the Dow Jones Industrial Average peaked at a record high of 11,722.98 and not until this year has the index been able to approach that level again, "knocking at the door, coming within 100 points of it and then pulling back," says Adrian Mastracci, president and chief investment officer at Vancouver-based KCM Wealth Management Inc.
But given that inflation over that six-year period was about 15 per cent, today's Dow would have to rise to about 13,500 to equal the old 2000 high.
"That means that most people who have invested heavily in the U.S. market since then have experienced losses," after considering inflation and currency adjustments, Mr. Mastracci says.
Those currency adjustments have pummelled Canadian investors in U.S. markets in recent years as the loonie has soared to about 90 cents (U.S.), slicing into any gains that might have been made when proceeds were converted back into Canadian dollars. Recent speculation that our currency could reach par with the greenback is a real worry for Canadians investing in the U.S.
That surging loonie is hardly surprising, given that Canada is the only G8 country running twin surpluses, says Mr. Graham, who predicts the Canadian dollar will hover around 85 to 90 cents in the near term.
One wild card for the U.S. and the rest of the world is the price of oil, Mr. Brieger says.
"The world can quite happily cope with $70 [a barrel] oil, but I'm not sure it can handle $100 oil," he says. "So if there is an interruption in supply, for whatever reason, the world could be tipped into recession."
Another factor is capital spending, which Mr. Brieger predicts will pick up in the U.S.
"There has been very little corporate and government spending on infrastructure there, and I think increased capital spending could offset any slackening in consumer spending," he says. "If that happens and economic growth continues, the Fed might push its rate up to 6 per cent from the current 5 per cent, and that would prop up the U.S. dollar and also slow the rise of the Canadian dollar."
Mr. Brieger says investment managers at his firm are buying such U.S. companies as Caterpillar Inc., Cummins Engine Co. and Crane Co. in expectations there will be an increase of 15 per cent in capital spending on infrastructure in both the U.S. and Canada.
Deficits remain the darkest shadow looming over the U.S. economy, investment experts say.
"The U.S. is like a mammoth supertanker trailing red ink, running massive deficits," Mr. Graham says. "There's the budget deficit of around $350-billion, which is about 2.5 per cent of its GDP, and an annual current account deficit of approximately $800-billion, which is about 6 per cent of their GDP."
Six years ago, in 2000, the U.S. was operating with a modest budget surplus, Mr. Mastracci says. "Every time you go from a surplus to a deficit, you lose your freedom and flexibility, because you need money to fund that deficit and you have to depend on someone else to give it to you."
The U.S. is sucking up about 80 per cent of the world's savings, with countries such as China, India and Japan propping up the government by buying its Treasury bills and thus providing the much-needed capital to finance the deficits, he says.
To finance the deficits, the "government is effectively giving the country's capital away to China and India," Mr. Jarislowski says. In addition, he says, "taxation in the U.S. is far too low, and despite that, there is no household saving."
Talk of a housing bubble also makes investors jumpy.
To rescue a faltering economy hit by the 2000-2002 bear market, the U.S. Federal Reserve Board gradually knocked its key rate down to a long-time low of 1 per cent, sparking a consumer spending spree on cars and houses.
As the economy recovered, the Fed gradually raised the rate to the current 5 per cent, Mr. Graham says, but soaring real estate prices have created what many are calling a housing bubble, which some fear is poised to burst.
A fall in the housing market would hit both stock markets and the economy, Mr. Mastracci says. "When rates were low consumers borrowed against their houses and spent the money, so there will very likely be a cut in consumer spending if house prices fall. Certainly those prices can't keep growing at this breathtaking pace."
Over all, although the economic pendulum is swinging toward Asia, the U.S. is still the epicentre of the world, Mr. Graham says, and its "economy and corporate profits keep defying the experts."
American stats
- The U.S. economy has had its share of ups and downs.
- $350-billion budget deficit in U.S. dollars, which is about 2.5 per cent of the country's GDP.
- 4.8 per cent annual GDP growth in the first quarter of 2006.
- 13,500 level the Dow Jones industrial average would have to reach to equal its 2000 high of 11,722, accounting for inflation.
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