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Who’s Behind Canada’s Big Market Rally?

By Ari Charney on June 16, 2016

Right now, the referendum on the so-called Brexit, the U.K.’s looming vote on whether to exit the European Union, has given the global markets jitters. Nevertheless, the Canadian market is still up big since its late-January low, especially when returns are translated into U.S. dollars.

In addition to the market’s move higher, U.S.-based investors are currently enjoying a huge tailwind from the Canadian dollar’s rise from recent lows. In U.S. dollar terms, Canadian stocks are up a whopping 33.5% from their year-to-date low. Feels good.

Of course, the market is still down about 6.1% over the trailing year, so the average retail investor is largely in the dark about the Canadian market’s more recent performance.

But while mom-and-pop investors have overlooked this rebound, the smart money has been quietly building its position. In particular, overseas investors have taken advantage of the drop in the exchange rate by swooping in and scooping up Canadian stocks by the billions.

True, even smart-money investors were temporarily sidelined during the market’s fearful tumult back in January. That month, foreign inflows into Canadian equity and investment funds dropped to a paltry C$142 million, though given the market’s volatility in recent years this short-term trough was hardly the worst performance.

Since then, however, foreign investors have piled into Canadian equities, gobbling up an average of C$4 billion per month over the three months through the end of April. That’s nearly triple the monthly average of inflows over the trailing five-year period.

And that action may have been what helped the benchmark S&P/TSX Composite Index roar ahead of other countries’ stock markets over that same period.

The buying activity was just as pronounced when you include all Canadian securities, such as bonds, money market instruments, and stocks. On that score, according to Statistics Canada, the country has seen four consecutive months of heavy foreign investor inflows, enough to produce significant net inflows in each month, even after balancing that out against Canadian investments in foreign securities.

Since the beginning of the year, foreign investors have bought roughly C$15 billion of Canadian securities per month through April, which is nearly double the average monthly inflow over the trailing five-year period as well as the trailing year.

In fact, the April total for all debt securities, about C$13.5 billion, was the highest such investment in a year, according to the agency. The action in this area has likely contributed to the recent rise in the exchange rate.

Of course, that doesn’t mean there isn’t a bumpy road ahead.

In addition to global economic uncertainty, there are also Canadian-specific concerns, including an overheated housing market, the toll taken by the wildfires in Alberta, and the continuing slump in energy-sector investment.

Though policymakers are trying to engineer a soft landing for the country’s real-estate market, central bankers and other financial regulators have a mixed record when it comes to pricking a bubble in a manageable fashion.

And the wildfires, which not only caused serious destruction but also curtailed significant energy production in Alberta’s oil-sands region, are expected to shave as much as a full percentage point off of second-quarter gross domestic product (GDP) growth, enough to cause a temporary economic contraction.

Finally, as Bank of Canada Governor Stephen Poloz recently observed, even the recent rebound in oil prices probably won’t be enough to spur new investment in the country’s energy sector, which accounted for about one-third of all business investment during the boom. Instead, investment levels are expected to be about 60% below 2014 levels.

Even so, while downside risks remain, the worst is probably over. Consequently, as Poloz put it when discussing Canada’s growth trajectory, “Continued patience is required, but we have the right to be optimistic.”

Certainly, you don’t get to buy bargains when everything is hunky-dory. That’s why the smart money has backed up the truck and loaded up on Canadian securities in recent months. They, too, see better times ahead.

Of course, the great thing about being an income investor is that a portfolio of dividend-paying stocks makes it easy to wait for those better times. After all, you get to enjoy a steady stream of income regardless of whether the market is in panic mode. At present, the average yield of the 24 stocks in Canadian Edge’s Dividend Champions Portfolio is nearly 4%.

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