Most Canadians invest in what they know best which tends to be Canadian companies. This tendency to invest predominantly in the country we reside in is known as a home country or domestic bias. There are many reasons why it makes sense to invest outside of Canada including diversification and the potential for superior earnings growth.
Given the legal commonalities and tax treaties between Canada and the U.S. as well as the size and diversification of the U.S. economy, the first place most Canadians look to diversify their investment portfolio is south of the 49th parallel. As shown in this week’s chart, the valuation gap between U.S. and Canadian stocks is near an all-time high. In other words, Canadian stocks are currently trading at a historic discount to their U.S. peers. Why is this the case?
If I had room for another chart, I would have added one highlighting the exodus of foreigners from Canadian stocks – according to the latest data, foreign investors have dumped $37 billion dollars of Canadian stocks over the past 12 months. In stark contrast, foreign investment in the U.S. stock market is at an all-time high. Why are investment dollars fleeing Canada for the U.S.?
There are many factors driving this behavior. First, the U.S. is the world’s largest and best diversified economy. Second, the U.S. economy has been outperforming the Canadian economy. When you dig into the details, a few key themes and sectors appear to be driving most of this outperformance – technology, more specifically, Artificial Intelligence (‘AI’) as well as healthcare and biotechnology.
The productivity gap between Canada and the U.S. has been a hot topic recently and is related to the relative underperformance of the Canadian stock market. Increases in productivity require investment and investment dollars are mobile – investors can choose where they want to invest. Investment dollars are flowing into the U.S. at a record pace while fleeing Canada because foreign investors see better opportunities in the U.S.
Is this an opportunity to purchase Canadian stocks at a historic discount or is the underperformance of Canadian stocks a trend that will continue for the foreseeable future? To answer this, let’s consider the factors that drive foreign investment decisions – regulatory certainty, legal certainty, fiscal stability and growth. In terms of regulatory certainty, global investors are giving the nod to the U.S. over Canada.
Examples include LNG advancing much faster in the U.S. and attracting billions of investment dollars, Carbon Capture Utilization & Storage projects being built in the U.S. ahead of Canada due to greater regulatory certainty, the Canadian Government having to buy a pipeline to get it built to increase realized prices, royalties and taxes, etc.
In terms of legal certainty, investors shouldn’t see a difference between Canada and the U.S. When it comes to fiscal stability, Canada appears better positioned with our debt levels increasing at a slower pace than in the U.S. Finally, in terms of growth, investors are clearly voting for the U.S. Again, this is being predominantly driven by industries such as AI and biotechnology where the U.S. is a global leader.
In terms of productivity, investment and standard of living, Canada continues to lag our G7 peers. This has become such an issue that the senior deputy governor of the Bank of Canada, Carolyn Rogers, called it a “break the glass” emergency in a speech she made in Halifax on March 26, 2024. As Canadians, we need to ask why this is happening and what can be done to reverse this troubling trend.
Eric Van Enk is a wealth adviser & associate portfolio manager with National Bank Financial in Medicine Hat. He is a graduate of the University of Calgary, as well as a CFA charter holder with 20 years of financial markets experience in New York, Toronto and Calgary. He can be reached at eric.vanenk@nbc.ca
