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posted on 27 April 2016

The Loonies Rise: Too Far, Too Fast?

by Chad Fraser, Investing Daily

Investing Daily Article of the Week

As Canadian Edge analyst Ari Charney wrote in last week's Maple Leaf Memo, the Canadian dollar's recent performance is finally giving Americans who hold Canadian stocks something to smile about.

Since hitting a 12-year low of US$0.685 on Jan. 19, the loonie has soared 15%, to around US$0.79 as of this writing, thanks in large part to the rebound in oil prices, to which the Canadian dollar is closely tied.

The currency's impact on the four-month return of the S&P/TSX Composite Index has been breathtaking: In that time, the index has bounced 14% on a price basis in Canadian-dollar terms. But translated into greenbacks, that gain becomes an astounding 32%.

It's a nice gift for long-suffering U.S. investors, who've watched the plunging loonie grind away at their Canadian stock portfolios. The loonie dropped 35%, from its post-recession peak of US$1.06 in July 2011 to its aforementioned low, before staging its latest comeback.

But could today's benefit come at the expense of slower growth - and lower corporate earnings - down the road? Possibly. And weak manufacturing numbers in February didn't do anything to dispel those worries.

The report, released last week, showed a 3.3% decline in the value of all shipments from January. That was worse than the 1.5% loss economists expected and came after three straight months of gains. The segment that took the worst beating isn't a surprise: petroleum and coal, down 12.6%.

However, the value of auto shipments plunged 10.5%, snapping a four-month growth streak. That's a concern for an industry Bank of Nova Scotia (TSX: BNS, NYSE: BNS) recently said is

"single-handedly lifting Canadian manufacturing and non-resource exports out of the doldrums."

It also casts a shadow over February's GDP numbers, due out April 29.

To be sure, the loonie's surge started too late to have a meaningful impact on February's manufacturing numbers. But what would a continued rise mean?

First, it's important to keep in mind that even though the Canadian dollar's surge has been impressive, from a historical perspective, the currency isn't especially high right now. According to data from Canadian Forex, the loonie averaged US$0.7805 between 1990 and 2015, just below the currency's present level.

Mike Moffatt, an economist at Western University in London, Ontario, told Maclean's magazine on March 31:

"If [the loonie] went back above US$0.90, it would start to put some of this at risk."

Moreover, there's up to a two-year lag between currency movements and their full impact on the Canadian economy - and two years ago, the Canadian dollar stood at US$0.91.

That doesn't mean the surging loonie isn't a big deal for Canadian businesses - it is - but in the short run, the currency's volatility is the bigger issue because it makes long-term planning difficult. That's particularly true for exporters and companies thinking about importing new equipment, which is key to improving Canada's weak labor productivity rate.

And even at its current level, the loonie is still a plus for Canadian companies that do significant business in the U.S., including some of the stocks we recommend in Canadian Edge.

Of course, no one knows where currency rates will go from here, but don't be surprised if the Bank of Canada makes a stronger effort to "talk down" the currency to protect the economy's shift away from resources.

That may help limit the Canadian dollar's near-term rise. But other factors point to a stronger loonie in the long run, including an expected rebalancing of the oil market and higher crude prices later this year and in 2017. On balance, that's good news for U.S. investors who own Canadian stocks.

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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