U.S. equities may have lagged Canadian returns recently, but they are likely to outperform in the long-run, say TD Bank economists in a new report.

“Over the past few years, Canadian investors have seen their holdings of U.S. equities perform quite poorly,” TD notes. “To begin with, the bursting of the tech bubble produced the deep market correction in 2000-2002. Then, U.S. equities rallied strongly in 2003-2004, but the gains were virtually offset by a surge in the Canadian dollar. The loonie’s advance was checked in 2005, but the major U.S. equity indexes have largely treaded water this year.”

And, TD concedes that the near-term economic outlook suggests that U.S. Equities, “will face a challenging environment of rising short-term interest rates, continued high energy prices and slower economic growth, with the latter occurring over the course of 2006”. That said, looking out to the long-term, it suggests that “there is a strong case to recommend U.S. equities”.

It argues that U.S. population growth will be stronger than most other industrialized countries, noting that the Population Reference Bureau forecasts that the population of the U.S. is expected to rise by 19% by 2025, compared to 13% in Canada, 7% in the U.K., 6% in France and contractions in Japan, Germany and Italy. And, it believes, there is also good reason to believe that the U.S. will record stronger productivity growth than most other industrialized countries.

“Higher population and productivity growth implies that the U.S. is likely to experience a faster trend rate of economic expansion than the rest of the industrialized world, which should support relatively stronger corporate profit growth,” it says. TD Economics forecasts that U.S. real GDP and corporate profits will rise at an annual pace roughly 1 percentage point faster than the G-7 average over the next two decades. “That may not sound like much, but it implies a cumulative compound outperformance of 22% between now and 2025. And, to the extent that equity valuations reflect long-term profits growth, the implication is clearly positive for U.S. equities.”

“This is not really ground breaking analysis, as the S&P500 has outperformed most other developed country stock indexes over the past 20 years, delivering an average annual total return of around 12% in Canadian dollars. We don’t expect that performance to be matched in the future, but we do expect an average annual return of 7% to 9%,” it says.