About three years ago, I wrote an article about the iShares MSCI Canada Index Fund (EWC), saying how not to analyze single-country funds. I also talked about the virtues of investing in Canada and setting reasonable expectations. Now is a good time to revisit that thesis.
Foreign diversification can provide benefits but can't protect you from a global downturn. Canada is a resource-based economy, compared with the U.S., whose economy is driven by services. Canada is a surplus country, whereas the U.S. is a deficit nation.
These sorts of differentiators create the possibility of owning a country (Canada) that is on dissimilar stock-market and economic cycles. In looking at the chart at the bottom of this story, you can see that Canada, as measured by EWC, peaked in May 2008, seven months after the U.S. and iShares MSCI EAFE Index ETF (EFA), representing Europe and Asia, hit a high. There were several other commodity-based countries, like Norway and Brazil, whose equity markets also rose to records seven to eight months after the U.S.
The global slowdown has obviously taken down most stock markets, so exposure to commodity-based markets has simply provided a smoother ride from the U.S. peak in October through the second quarter. If you follow the news from Canada, you also know that this week the Bank of Canada declared a recession right on the heels of the U.S. declaring its own. The difference is that the U.S. recession was dated back to last December.
Obviously, none of the commodity-based equity markets were immune from the selloff. In fact, once they started to drop, the decline was steeper and had greater velocity than the U.S. That these markets, including Canada, held on so much longer makes them worth owning for me. But an investor willing to invest at the country level for his foreign exposure needs to decide for himself whether this is appropriate. Clearly, there was a need to take some money off the table with an exit strategy.
Does investing in Canada still make sense? Canada is obviously resource rich. Energy comprises 28% of EWC and materials 13%. Both sectors are down dramatically in a very panicked fashion due, in part, to fears of the global economic slowdown. If you buy into the longer-term idea of commodity demand from places like China, then Canada offers a politically stable way to benefit from the long-term theme.
The financial sector is the largest group in EWC, at 35%. This is a potential red flag given what is still happening with banks. That said, the six largest financial names in EWC are down much less than the Financial Sector SPDR (XLF).
In the short run, it is very unlikely that Canada or any other commodity destination provides much outperformance for a portfolio. The context for this article is to try to add value with global diversification over the course of an entire stock-market cycle. Canada will do that over the longer term even if the last few months and the next few months do not offer much in the way of differentiated returns.