This is very similar to the action in the energy sector last year.  We feel the materials have a significant catch up trade and need to be overweight.  While the Canadian stock market appears to have been ‘last to the party,’ we are drawing the attention of global investors.  The chart below shows Net International Investment Flows for Canadian debt (bond) and equity (stock) securities.  While our solid economic performance and banking system strength during the financial crisis in 2008 lead to significant foreign purchases of Canadian bonds over the past five years, stocks were less popular, with the market seeing net redemptions by foreign investors in 2013.  Those trends appear to have reversed in the past six months as foreign bond purchases have dropped sharply while stock purchases have picked up.

Canadian Stocks Appeal to International Investors

The most significant buying appears to be in the Energy sector, where U.S. and European investors are stepping back into Canadian oil and gas stocks as the spread between global oil prices and Canadian heavy oil (WCS Select) have narrowed and natural gas prices have surged.

The financial crisis got started in the U.S. housing market as borrowers feasted on all types of new credit instruments and lax lending standards to accumulate record debt levels.  Home buying by speculators helped drive annual U.S. housing starts to record levels of close to 2 million homes, in an economy where annual household formation (and, hence, housing demand) was around 1.4 million.  This created massive over-supply which ultimately lead to the collapse of the housing market and the banking crisis which, in turn, set the table for the global economic crisis that followed.  The chart below shows that a lot has happened since those dark days back in 2008.  Not only have consumer debt levels come down (from over 135% of ‘disposable income in 2007 to under 110% today) but the cost of servicing this debt has also fallen due to the fact that interest rates have fallen to all-time lows.

U.S. Household Debt Declines

This has effectively put more money into consumers’ pockets to spend in other areas of the economy, although higher gasoline prices are clawing back some of those gains.  This ‘debt retrenchment’ over the past few years also explained why the economic recovery had been so lacklustre compared to prior recoveries; consumers were directing much of their excess income to paying down debts rather than new spending.  With debt levels back to more ‘normal’ levels, we should start to see a pick-up in spending, which would add further fuel to the economic recovery.

Of course we have to point out that this data all refers to consumer debt loads.  While consumers have been retrenching over the past seven years and reducing debt, the government has taken over and being the big borrower, amassing total debt in excess of US$15 trillion!

The bottom line is that we remain long-term bulls on the stock market due to a growing global economy, low levels of long-term interest rates and a secular increase in corporate profitability.  As per usual, I would be more than pleased to answer any questions.

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