By: Jeff Pollock
July 27, 2017
If you’re buying US securities irrespective of the currency you spend money with (likely the Canadian loonie), you shouldn’t.
Some argue that currency is a wash. But it makes quite a difference if you pay attention to the numbers. Since 2011, owning US denominated securities has resulted in a sizable currency gain. After all, the loonie fell from over par in 2011 to $0.68US last January 2016. In recent months, however, the weak Canadian currency that we’ve all become accustomed to finally moved the opposite direction.
So far this year, the S&P 500 has gained an impressive 10.6%. This compares to a meagre 0.6% decline by the S&P/TSX Composite Index here at home. However, just like the S&P 500, the loonie has also appreciated quite significantly in value. While it started the year at $0.74US, our local currency now trades around $0.80, representing a 7.5% appreciation year-to-date.
The net effect has been to wipe out almost 70 percent of the S&P 500’s gains when converting back into Canadian dollars. In other words, a Canadian fully invested in the S&P 500 has achieved a 3.2% return so far in 2017, quite less than the 10.6% that appears on the surface.
The loonie has bounced back this past month as the Bank of Canada increased rates for the first time in seven years. At the end of May, the market was short 99,000 currency contracts in anticipation of a further decline in value. However, throughout July, those bets were swiftly covered and reversed. As of July 21, there were 8,000 long contracts, indicating the first bullish stance undertaken by the market since March. This all suggests that the loonie may have further room to run. Economists project another rate hike in Octber, followed by a third increase in Q3-2018 and then another in Q4-2018.
I’ve always believed that the loonie is the hardest working currency this planet has to offer. While forecasting its movement is a mugs game, the reasons for investing in the US are clear. Canada lacks the diversity that a balanced portfolio requires. Financials represent almost 37% of our index, followed by 20% in Energy, and 12% Materials. Despite Technology rapidly gaining more dominance (and now constituting 6 out of the 10 top global brands), it represents less than 3% of our exchange. Our index is weighted by the market capitalization of its constituents, so the usual suspects (Royal Bank, TD Bank, Scotia, Enbridge, CN Rain, Suncor) are to thank for its gain or to blame for its loss in any given period.
We look south of the border for investment opportunities unavailable here at home. This isn’t to say that if a sector is well represented in Canada that we wouldn’t invest in a US competitor. We’ve bought US securities for clients in sectors that are widely available domestically based strictly on more favourable valuation metrics, and will continue to do so. However, currency is one of the many factors our Investment Committee considers when constructing portfolios in segregated accounts for clients. Now that Canada has begun to raise rates, it will continue to be a heavy consideration when making an investment south of the border.
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