Can Canada Keep It Up?

Is it too late to head for the Great White North?

Canadian stocks were the easy way to go last year, as rising commodity prices and a strengthening currency lifted shares 13%. Nevertheless, with oil prices thought to be topping off and the U.S. dollar bottoming out, investors are wondering if Canadian companies will provide a third straight year of gains.

Maxime LeMieux, portfolio manager for the $646 million ( FICDX) Fidelity Canada fund, highlights interest rates as the key to Canadian stocks' performance in 2005. According to LeMieux, if interest rates move up too quickly it's going to hurt the mining and energy stocks that have powered Canadian equity returns. And LeMieux's personal performance over the past two years makes him a good source on our neighbors to the north. In 2003 and 2004, his fund returned 51.9% and 23.9%, respectively.

The Great White North
Fidelity Canada Fund
Fund/Index Ticker YTD % Annual Returns % Expense Ratio %
2004 2003 2002
Fidelity Canada Fund FICDX -4.75 23.9 51.9 -4.3 1.42

TheStreet.com checked in with LeMieux to get his thoughts on Canadian stocks in 2005 -- and, perhaps more important, how Canadians are surviving without hockey.

What are your projections for Canadian stocks in 2005, coming off two very strong years?

After two strong consecutive years, it will be harder to achieve similar results, especially if the Canadian dollar stabilizes, because that would mean no gains as a result of currency movements. If earnings growth decelerates and interest rates continue to rise, that would also make it tough to see positive returns this year. Finally, natural resources account for a third of the Canadian market; therefore any slowdown in demand for commodities would put some pressure on the market.

How is the weak U.S. dollar affecting Canadian companies and the Canadian economy?

A weak U.S. dollar is obviously a negative for Canadian exporters and a positive for companies that import goods to Canada, such as retailers. The industrial and manufacturing sectors are particularly affected, given that they usually export a big portion of their production. The latter is mostly done in Canada, so production costs do not change, but they get less for their goods sold in the U.S. given the currency impact.

As for the impact on the Canadian economy, I would say that it could be a long-term positive since it forces corporations to become more productive, which means more competitive on a worldwide basis. However, if the U.S. dollar were to depreciate further and faster, it would likely become a negative, as most exporters would feel the pain and the whole economy could slow down as a result.

How will an increase in interest rates in America affect Canadian stocks? What do you see for Canadian interest rates?

If interest rates continue to increase in the U.S., Canada typically would follow, but probably at a slower pace assuming the Canadian dollar does not get much stronger. Capacity utilization is fairly high in Canada and there is a risk of higher inflation. However, Canada has a positive trade balance and the government continues to generate budget surpluses that enhance the investing environment.

Your fund has a lot of bank stocks like Canadian Imperial Bank of Commerce (BCM), Bank of Montreal (BMO) and Toronto-Dominion (TD). Why do you like this sector? Which names do you like? Do you see any M&A possibilities?

Banks represent more than 20% of the Canadian index. The fund recently has been underweighted in banks because, in an environment of higher interest rates, my belief has been that these stocks may not perform as well as what we have seen in the past few years. However, one has to remain cautious since there is always a small possibility that the banks may be allowed to merge, which would create significant upside for some of these stocks.

Canadian energy stocks such as EnCana (ECA) have become very popular with U.S. investors as oil prices have risen. What do you project for energy prices in 2005?

It was not a surprise to see U.S. investors buying Canadian energy stocks, since both oil and natural gas prices were increasing throughout 2004. What's next? If the barrel stabilizes around $40, I think that there could be opportunities in these stocks given current valuations. One has to watch the global demand for oil, which I think could eventually get softer if interest rates increase too fast in the U.S.

But remember that natural gas has been in a real decline mode in North America and it has become more expensive to produce. Therefore, the long-term outlook has appeared positive in terms of pricing.

Mining stocks like Placer Dome (PDG) have run up as well due to gold's rise. What is your opinion of mining stocks going forward?

Mining stocks were on a tear in 2004, given rising commodity prices such as copper, nickel and gold. The weakness in the U.S. dollar also explains the strength in that sector given the negative correlation. I believe that the factor to watch in 2005 will be interest rates. If they start going up too fast, it will put pressure on the metals and therefore the stocks may not offer much potential.

One has to watch the supply and demand of each metal because some metals will face more supply later in 2005, which could hurt pricing. China is also an important secular driver, which is quite positive for the long term. However, the cycles will continue to take place within that secular trend.

How is the overall political situation in Canada vis a vis the United States? Did President Bush's recent trip start the healing process?

On the political scene, the two countries went through a difficult period given the divergence of opinion on the war, but I think that Mr. Martin and Mr. Bush will make all the efforts to enhance the relationship between the two countries. Economically, both countries depend somewhat on each other, so I am not concerned in the long-term about relations between Ottawa and Washington.

What are Canadians doing without hockey now that the NHL season has effectively been wiped out?

Since there is no hockey this year, Canadians are watching all the replays.

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