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the buy side

A year ago, I wrote a column inspired by a holiday in Arizona (my in-laws have that effect on me). The piece attempted to level a rather tilted picture of the United States, one that was firmly focused on dismal economic and political news. I suggested that from an investor's point of view, the U.S. didn't look so bad. Canadians were being given the chance to buy cheap assets with a richly valued currency (the loonie).

From the comments I received, I found out how intensely Canadian investors dislike the U.S., and how strongly they disagreed with my view. Well, I'm nothing if not stubborn, so I headed south again this year to continue my research. After 10 days in Florida and the Republican desert, I've returned with a higher golf handicap, five years worth of Nordstrom sweaters and a renewed desire to buy southern real estate.

Before revealing my other findings, it's useful to look at what's happened since last year's column. The politics in Washington have gotten more bizarre (I call it entrenched denial), the economy is still hanging on by a thread and the government debt grew by another trillion dollars or so. As for the housing market, prices were down slightly year over year and are 30 per cent below their 2006 peak.

The results were different, however, in the stock and currency markets. The S&P 500 was up 8 per cent for the 12 months to Oct. 31, while the S&P/TSX composite was down 1 per cent. The exchange rate has bounced around, but now shows the greenback a couple of pennies stronger against the loonie.

How did this happen? Well first of all, let's remember that one-year returns are pretty flaky, even bordering on random. The numbers could reverse with a two-week run of the gold and energy stocks. But beyond that, these results are a reminder of just how big a role sentiment (emotion) plays in short-term returns. A strong consensus often creates an opportunity to go in the opposite direction. The return gap is also a reminder of how important valuation is. Cheap assets priced in an undervalued currency help to offset many ills.

Having taken a fresh look at the U.S. (on foot and at my desk), my investment conclusion remains the same – Canadian investors need to be open to opportunities south of the border. Stocks and real estate are still cheap relative to what's available in Canada and the American economic outlook has improved relative to ours. The Americans are well along in adjusting to their new reality, while we've yet to have our comeuppance. The following factors illustrate what I mean.

The U.S. economy is growing almost as fast Canada, but with zero help from the housing sector, which is flat on its back. In Canada, real estate is contributing mightily to economic activity.

Government deficits in the U.S. are worse and the accumulated debt now exceeds Canada's (as a percentage of GDP), but we're running large deficits too (embarrassingly so given the health of our housing and resource sectors), and our consumer debt burden is now heavier.

There's no question that the U.S., with its cheaper land, labour and currency, is now more competitive than Canada and the gap is widening. Last week it was reported that U.S. productivity gains are running well ahead of ours. This week Chrysler chief Sergio Marchionne opened contract negotiations with Canadian workers by saying, "You cannot have all things. You cannot have a strong currency, you cannot have an uncompetitive wage rate and then expect Chrysler or all the other car makers to keep on making cars in this country and be disadvantaged."

The point is that investment managers are always looking for changes at the margin. Improvements that are unappreciated by the market. A poor situation that's turning around. They're not always looking for good, just better. If the sentiment toward the U.S. improves and concerns about insolvency abate, then the attractiveness of U.S. stocks will become apparent.

As investors, we need to check our emotions at the door and critically assess each opportunity on its fundamentals and valuation, regardless of head office location. Which reminds me, now I've got to wangle a golf trip to Europe.