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From ‘sell Canada’ to ‘buy Canada’: TSX is picking up

Investors are warming up to Canada again, after placing the country's stock market in the "sell" category about two-and-a-half years ago. Since the start of the third quarter, the S&P/TSX composite index has risen 5.8 per cent or more than 2 percentage points better than the struggling S&P 500 – and observers are noticing.

"The slate of solid bank earnings and the now rather obvious fact that Canada's housing market is holding up very well have quieted the doom and gloom talk," said Douglas Porter, chief economist at BMO Nesbitt Burns, in a note.

"As well, the distinction between the staggeringly strong (if slightly unbelievable) Canadian jobs increase in August of 59,200 and the so-so 169,000 U.S. payroll gain could not have been sharper."

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This marks an interesting shift. As we noted in this space in mid-May, the "sell Canada" trade had begun to look crowded. Marc Faber, Stanley Druckenmiller and Steven Eisman gave the thumbs-down to Canada, based largely on a bubbly housing market and declining commodity prices. A hedge fund manager named Vijai Mohan famously bet 95 per cent of his fund against Canada, by short-selling stocks.

The bad news looked largely priced in, given the overwhelmingly negative views on Canada. Sure enough, the stock market is now doing okay: The S&P/TSX composite index is just 50 points shy of a two-year high.

Commodity producers, which represent about half the index in terms of their collective weighting, were a big drag on performance earlier. Now, they are showing signs of life. Materials have risen 9.7 per cent since the start of the third quarter, and energy stocks have risen 5.5 per cent. Telecom stocks have also rebounded from an earlier selloff, and are now up 4.1 per cent since the start of July.

Is it time to jump into Canada? The outperformance of the S&P/TSX is a mere two-month trend so far, which means we could be witnessing little more than a blip. As well, concerns continue to hang over the country's housing market, while bank stocks have been hitting record highs.

Overall, though, Canada still looks like a compelling opportunity, given its underperformance in recent years. It is down 10 per cent since 2011, and it is down nearly 15 per cent from its record high in 2008. Compare that to the S&P 500, which hit a record high at the start of August and is 6 per cent above its 2007 peak. Even large-cap European stocks, weighed down by the euro zone's recession and sovereign debt crisis, have outperformed Canada over the past two years.

Besides being unloved (the sentiment shift is debatable at this point), the Canadian index also comes with a dividend yield of 3.1 per cent, a full percentage point bigger than the yield on the S&P 500.

In other words, if you want to get paid for sitting around and waiting for a rally, the Canadian market will pay you considerably more right now. But if the trend since the start of the third quarter picks up speed, you might not have to wait around too long.

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