Canadian Banks No Longer Leading US Banks. Trouble Ahead For The Canadian Economy?

The Canadian banks (XFN) have outperformed their US counterparts (XLF) since 2009.  They have been placed on a global pedestal due to their reluctance to participate in the subprime mortgage debt and collateralized debt obligations that precipitated the Great Recession.  Their balance sheets remained extremely healthy and their stock prices reflected this to this day.  But that was then...

Two of the 4 wheels have blown on the car that is the Canadian economy.  Precious metals and material stocks are down some 70% since 2011.  Now stocks of energy producing companies are free falling in tandem with the price of oil which seems to be in global abundance despite the fact that the opposite view held the public consensus only 6 years ago.  Don't get me started on the Canadian housing market.

Banks and financial sectors reflect the overall health of a country's economy.  Their relative performance is predictive of the relative performance of a given country's economy.  The chart above would suggest that growth in the US economy will continue to outpace that of the Canadian economy.  If the Canadian bank index is unable to post new 52-week highs and/or trends lower trouble is ahead.

The S&P TSX Composite Index Will See New Highs In The Near Future

After the 1973-74 bear market, the TSE 300 (now the S&P TSX Composite Index) underwent a multiyear period of price consolidation prior to its breakout in 1978.  Do you see the similarities between now and then?  Note how bad the following 1982-83 bear market that succeeded the breakout was.  The early 80s recession was a very difficult time for Canada.

A Global Depression?

The iShares Global 100 (IOO) which tracks the S&P Gobal 100 Index, is essentially a picture of the global economy on one chart. It consists of 100 large cap international stocks. It is to the world what the DOW is to the United States. Several of its holdings are DOW components due to the dominant presence of the US in the global economy.

We can see from the chart that after a sharp recovery from March 2009 to Jan 2010, the chart has faltered and has retested break out level support at $50. We could test this strong support level again or trade at or near it for a period of time. A break below this support level would signal another global recession and a break below $40 would signal a global depression.

Economics is a progressive discipline, not a regressive discipline. Economies learn from past mistakes and become more efficient as time progresses, not less efficient. It is true that history seems to sometimes repeat itself as bubbles form and subsequently burst intermittently. However, this is due to the nature of human psychology, not ecomonics. Progress is cumulatively exponential in nature. The long term trend is always up.

Despite the intensely negative media reports, looking back 10 years from now, this could be the greatest buying opportunity of a generation.

Market Drift

2004 through 2005 was a relatively boring time for the stock market. The S&P 500 stood at ~1150 give or take a few points at the beginning of 2004 and stood at ~1250 a the end of 2005. This resulted in a mere gain of ~4% per year for this 24 month period. I realize that this is much better than the ~50% decline that most markets experienced in 2008, however, modest returns and normalcy in the market tend not to excite investors.

As the slow recovery in the US continues, the markets over the next year or two will probably provide less excitement than we've been used to lately. It is possible that the S&P 500 simply moves sideways or delivers very modest gains as extremely high unmployment in the US continues to wear investor confidence and dampen consumer spending during this slow recovery period. After the very deep 1973-74 bear market / recession, the S&P 500 traded in a sideways fashion for approximately 5 years.

Of course, there will be sectors or contries that will experience more than simply modest growth. From a technical perspective, several emerging market ETFs are still clearly in uptrends. The iShares Malaysia ETF (EWM) posted new 52-week highs today.

Canadian Real Estate Prices

The above chart nicely illustrates the fact that Canadian real estate prices have appreciated significantly for 10 straight years, correcting briefly during the great recession. As this graph climbs higher, owning a new home becomes increasingly expensive relative to renting. Notice that in 1989, real estate prices peaked and entered a 10 year period of price consolidation during the tech boom of the 1990s. The smart money left the real estate market and went into the stock market -- technology stocks in particular. The smart money left the US real estate market in 2008. The price-to-rent index in Canada can't climb indefinitely. Last summer appears to be a potential top in Canadian real-estate as prices are down markedly this summer in metropolitan areas such as the GTA , Vancouver and Montreal. It is possible that history will simply repeat itself and we may experience a prolonged period of stagnation as the speculators become frustrated with the Canadian housing market.

The more important question is where will the smart money head next?