Finding value and growth for your clients has been difficult, given that Canada’s stock market has been trailing Wall Street for six years.
The battle is uphill due to another basic problem: Canadian corporate profitability has been dropping for five years.
There is a possibility that Canadian stocks will do better than the U.S. market in the short term. But there is no sign of an upturn in the ability of Canadian businesses to boost their returns.
To understand the reasons, think of the basics of the Canadian stock market. It really is three markets: resources, financials and everything else.
In the S&P/TSX composite index, the resources sector (energy and materials) currently accounts for 24% of market capitalization, financials for 34% and everything else for 42%.
Only the financial sector’s earnings on the S&P/TSX composite index rose in 2016 to record highs. Resources earnings have collapsed. Everything else has not made significant progress since 2012; while index earnings are up this year, they are still below past highs.
Dividend payments, except for resources, continue to rise. For the financial sector, those increases are no problem. But for other sectors, dividend cuts look inevitable, given unimpressive profitability.
The stock market reflects only publicly traded businesses. Statistics Canada reports on everything, public and private. StatsCan divides Canadian enterprises into two categories: financial and non-financial.
StatsCan puts real estate into the non-financial category. By coincidence, the S&P/TSX composite index and similar Standard & Poor’s Financial Services LLC indices have just moved real estate out of their financial sectors and installed real estate as a new, 11th sector in their Global Industry Classification Standard (GICS) index system.
StatsCan’s quarterly reports on Canadian business as a whole reveal the decay in earnings power:
– Pretax return on average assets of non-financial enterprises dropped to 3.2% in the 12 months ended June 2016 (latest available data). This is a significant drop from a high of 5.2% in the 12 months ended March 2012 and in the 2011 calendar year.
Comparing these returns with the 6.9% high that was achieved in the 12 months ended September 2006 is even more helpful.
– In the financial sector, StatsCan figures indicate net return on average assets in the 12 months ended June dropped to 1.31%, vs 1.51% in the 12 months ended September 2014.
Returns in both periods were well below their 28-year highs: 1.87% in the two 12-month periods ended December 2006 and September 2007.
– Return on average equity (ROE) for non-financial enterprises was 6.6% in the 12 months ended June 2016. This is an uptick from a low of 6.2% in calendar 2015. ROE’s recent peak was 12.0% in calendar 2011. The previous high: 14.5% in the 12 months ended September 2006.
– In StatsCan’s financial sector, ROE dropped to 9.1% in the 12 months ended June, vs a recent high of 10.2% in the 12 months ended September 2014. ROE bottomed at 6.7% in the 12 months ended June 2009, having dropped from a 28-year high at 13.3% in calendar 2006.
– Although the financial sector’s earnings in the S&P/TSX composite index have been rising, StatsCan data disagree. Net income dropped by 3.0% in the 12 months ended June 2016 from the corresponding period a year before. This continues a negative trend that began in the 12 months ended September 2015.
– Non-financial industries’ profit margin has suffered. The earnings margin dropped as low as 3.4% in calendar 2015. An uptick in the 12 months ended June 2016 lifted it to 3.7%.
Those returns compare with a high of 5.7% in the 12 months ended September 2014 and a 19-year high of 5.9% in 2011.
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