If you're thinking of investing in Canadian companies that stand to benefit from a strong Canadian dollar, analysts have begun to compile helpful lists of potential winners and losers to help you along the way.But here's the problem: The stock market may have already factored in the loonie's strong gains.
The dollar's ascent has been spectacular over the past several months, blasting above 82 cents against the U.S. dollar earlier this month, up from 74 cents at the start of June. It has since settled back slightly, to about 81 cents.
The rise has coincided with a bullish economic outlook from the Bank of Canada, which took many economists by surprise. Since the start of the summer, the central bank has raised its key interest rate twice, by a quarter of a percentage point each time – and more rate hikes may be on the way.
At the same time, the U.S. dollar has been weak as the U.S. Federal Reserve faces a low inflation rate that could be holding back rate hikes of its own.
What should investors do?
Getting a handle on which Canadian companies are particularly sensitive to a strong Canadian dollar is a good start.
In general, companies with substantial revenues flowing from the United States get hurt by the stronger Canadian dollar, since these revenues are now worth less than they were last year. Conversely, companies with substantial costs priced in U.S. dollars will see these costs decline, which is a good thing.
However, based on our research, many companies that are tapped to benefit from the stronger loonie have already seen their share prices rise, suggesting that investors should be careful about following this trend: It could backfire if the loonie shifts direction.
National Bank Financial released a lengthy report on this subject last week, outlining the potential winners and losers in a number of different sectors.
Within the banking and insurance sectors, for example, analysts expect that the profits of five domestically focused names will see virtually no impact if the current exchange rate holds steady into 2018. Canadian Imperial Bank of Commerce, Canadian Western Bank, Laurentian Bank of Canada, National Bank of Canada and Industrial Alliance Insurance and Financial Services Inc. are virtually immune.
On the other hand, Toronto-Dominion Bank, Bank of Montreal, Royal Bank of Canada, Bank of Nova Scotia, Manulife Financial Corp., Sun Life Financial Inc. and Great-West Lifeco Inc. face a profit headwind of more than 1 per cent.
But share price moves since the start of June suggest that the market already knows this. The group of domestically focused banks and insurers are up an average of 11.3 per cent, compared with a gain of just 3.9 per cent for their more internationally focused peers and an almost unchanged S&P/TSX composite index.
Even if we discard Canadian Western Bank as an outlier, given that its share price may be rallying with greater confidence in the Alberta economy, the domestic group is up a leading 7.2 per cent.
The differences among transportation and industrials is even more pronounced.
Air Canada, WestJet Airlines Ltd. and Transat A.T. Inc. stand to benefit from the high Canadian dollar, given that fuel, leases and some maintenance costs are priced in U.S. dollars, according to the National Bank report. These stocks are up an average of 44 per cent since the start of June.
Companies that stand to lose out from the stronger Canadian dollar, including Canadian National Railway Co., Canadian Pacific Railway Ltd. and Bombardier Inc., are down an average of 2.2 per cent.
Perhaps airlines are in and railways are out. So here's another way to approach this subject: Take representative samples from the 262 companies mentioned in the National Bank report to get a broader look at about a dozen sectors.
We looked at the returns for 30 stocks, split evenly among dollar winners and losers. The difference between the two groups was narrow, but it exists: The dollar winners are up an average of 6.2 per cent since June, compared with a gain of 4.6 per cent for the dollar losers.
The takeaway? Continuing strength in the Canadian dollar should produce additional share-price gains for those companies with U.S.-dollar costs and Canadian-based revenues.
But be careful: Currencies are notoriously volatile. An uptick in U.S. inflation and rate hikes from the Fed could easily make today's winners tomorrow's laggards.