The Secret Rally

U.S. investors in Canadian stocks finally have the wind at their backs again.

Since the S&P/TSX Composite Index hit a trailing-year low on Jan. 20, the Canadian benchmark has climbed 15.3% on a price basis in local currency terms. Not bad, especially when compared to the S&P 500’s 11.9% rise over that same period.

But here’s where the U.S. market gets absolutely blown away.

The inception of that period roughly coincides with a 13-year low for the Canadian dollar, just below US$0.69. Since then, the loonie has headed steadily higher, recently trading at US$0.78, or nearly 14% off its low.

Thanks to the compounding effect of a rising exchange rate, the Canadian stock market’s performance over that period has been positively sizzling for those U.S. investors who were savvy enough to take advantage of the exchange rate’s low, as Canadian Edge advised.

Since Jan. 20, the Canadian stock market has jumped nearly 31% in U.S. dollar terms. Yes, we checked those numbers twice (okay, probably half-a-dozen times—we’re a bit obsessive).

At the same time, longer-term U.S. investors in Canadian stocks have a little less to be enthused about. If they piled in when the Canadian dollar was trading near its high against the greenback, which would have been US$1.06 back in July 2011, then they’re still down about 26.4% in U.S. dollar terms.

Despite the risk of a falling exchange rate, it’s good to have at least some currency diversification in your portfolio. After all, the next global commodities super cycle will likely see the Canadian dollar ascendant once again.

In the interim, however, Canadian policymakers are somewhat less than thrilled about the loonie’s recent rally.

Although the Bank of Canada (BoC) was largely silent on the rise in the exchange rate in previous months, this week the central bank tried to rein things in a bit. In its latest quarterly Monetary Policy Report, the BOC noted that while non-commodity exports are still expected to increase solidly this year, the loonie’s ascent has prompted the bank to revise its estimate lower from January’s forecast.

Even before the energy sector entered a protracted downturn, the BoC had been looking for export-oriented manufacturers to help lead the economy. That transition has been slow in coming, though the lower exchange rate has been key in facilitating the shift.

Economists with CIBC saw the BoC’s mention of the Canadian dollar’s sudden strength as noteworthy. Their take is that the central bank is trying to “caution markets about taking the loonie much further.”

In fact, it looks like the BoC would prefer that the current level of the exchange range represent the upper limit of the currency’s medium-term trading range. The central bank’s forecasts assume that the loonie averages around US$0.76 over its projection horizon, up from US$0.72 in January.

So U.S. investors should enjoy the Canadian dollar’s rally, but not necessarily expect more of the same in the months ahead. If the loonie does rise further, then the BoC could use its bully pulpit to talk the currency lower.

Or the Canadian dollar could take a hit if energy prices retreat again. The performances of both equity and currency markets have been highly correlated to energy prices so far this year, and crude could see another selloff, even if we’ve already witnessed the ultimate bottom for this cycle.

If oil prices were to decline meaningfully from current levels, then the loonie would likely fall in sympathy. Of course, that would be another opportunity to back up the truck and load up on high-quality Canadian dividend payers in anticipation of another rebound.

Our Super-Secret Stock Pick

In May, we’re holding our annual Wealth Summit–this year in Las Vegas. It’s a great way for us to meet you, our subscribers, one-on-one, and there are still spaces open if you’re interested.

Also this year, we’ll be making a special recommendation to those who attend the Summit, and to those who are part of our Wealth Society, whose members receive all the Investing Daily newsletters and other premium services.

It’s a fun exercise for us because there are no rules. We don’t have to pick a Canadian stock. In fact, our pick doesn’t even need to be a stock: It could be an alternative investment that isn’t traded on a public market.

Our publisher says we can’t reveal the pick in Canadian Edge, or even to him before the Summit. But in the weeks ahead, we’ll let you in on some of the research we’re doing to identify this exclusive pick.

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