Skip to main content

The market volatility since Britain voted to leave the European Union gives nervous investors even more reason to figure out where else they can put their money.Aaron Vincent Elkaim/The Canadian Press

Here's an uncomfortable question for frightened Canadian investors: Can the rally in non-commodity stocks really last?

As financial markets gyrated over the past two years, fuelled in part by the collapse in oil and gas prices, Canadian investors have pumped more money into less-volatile sectors and stocks. Often, that meant fleeing commodities and piling into utilities, telecoms, retailers and consumer staples companies.

Since September, 2014, when the oil rout began to turn ugly, shares of Metro Inc. have jumped 92 per cent, Dollarama Inc. is up 93 per cent and BCE Inc. popped 23 per cent – a major climb for a slow-growth company with a juicy 4.5-per-cent dividend yield.

Soaring stocks translated into deals. The shift toward companies with more stable earnings lit a fire under Canadian initial public offerings, which were ablaze last year as companies including Cara Operations Ltd., Spin Master Corp. and Hydro One Ltd. listed on the Toronto Stock Exchange.

Because the runup was so rapid, and because share valuations in some sectors have become so stretched, investors already had reason to question whether the rally would run out of steam. Then came the Brexit referendum. The market volatility since Britain voted to leave the European Union gives nervous investors even more reason to figure out where else they can put their money.

There is no clear cut answer. One of the enduring truths postcrisis era is that historical benchmarks, including metrics such as price-to-earnings ratios, aren't as reliable as they used to be. We are in a brave new world, one with ultra-low or even negative interest rates on government bonds that distort markets.

"If we run our valuation work on utilities, consumer staples [and] to a lesser extent telecom – the places that folks have been looking to hide – there's no doubt that all of these sectors are at the very high end of their historical valuation bands," said Matt Barasch, head of Canadian Equity Strategy at RBC Dominion Securities. "You'd have a hard time saying that [valuation] wasn't at least at worrisome levels."

Some examples: Power producer and distributor Emera Inc.'s stock is trading near record levels; BCE shares are trading at 17.5 times earnings, near their highest ratio since the company was subject to a takeover offer in 2008; TransCanada Corp.'s price-to-earnings ratio sits at 22.7, far above its historical average of 16.6, even though the company failed to win approval for its Keystone XL pipeline in the United States.

But even numbers like that might not be enough to slow the rush of money into hot sectors. "You can't just look at these things in isolation," Mr. Barasch said.

Historically, dividend yields for utilities and telecoms were assessed relative to benchmark rates on government bonds. Those yardsticks keep moving. "I'll tell you [the hot stocks] are expensive if you tell me where the 10-year bond yield is going to be in three years, five years, 10 years," Mr. Barasch said. "If it keeps dropping, then they're not expensive at all."

Add in the fear factor and there's even more fuel for these already-sexy sectors. Market shocks have continually popped up since the financial crisis – the EU's sovereign debt woes, the collapse of Cyprus's banks, the freefall in energy markets, the Brexit vote – and the unending upheaval has kept investors on edge.

Amid all the uncertainty, people have flocked to what they view as tried and true. "Canada and the United States have the best brands in the world. Period," said Brian Belski, cief investment strategist at BMO Nesbit Burns, citing companies such as Canadian Tire as examples.

That goodwill is especially important here. Because Canada is such a small market, there are only a handful of solid, safe companies to invest in. "The problem with the Canadian market is there's a real scarcity of ideas," Mr. Belski said. "Everybody owns the really good ideas."

That very dynamic is a key reason Hydro One's shares have performed so well since they first hit the market – up 24 per cent in seven months. When the company went public, former Toronto-Dominion Bank CEO Ed Clark, who was a driving force behind the scenes, was adamant that Canada doesn't have enough quality publicly traded companies, and that dearth would be of benefit to the utility.

Despite the phenomenon, investors have to be cautious because they can't blindly buy into sectors. Within the telecom industry, Western Canada-based Telus Corp. has dropped 3.5 per cent in the past year on worries about Alberta's economy. Empire Co. Ltd., which owns the grocer Sobeys, is down 29 per cent, largely driven by a $1.7-billion writedown on its acquisition of Safeway Canada.

Investors must also be aware of emerging opportunities. Real estate investment trusts spent three years in the dog house but have roared back this year. The S&P/TSX capped REIT index is up 16 per cent since January.

"In a world with rates as low as they are, I don't think it's all that surprising that these things have caught a pretty strong tailwind," Mr. Barasch said of the trusts.

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe