Back in March of this year I warned readers that the Canadian equity market as represented by the S&P/TSX Composite Index would have a hard time staying above EBV+2. If you don’t remember my words maybe you will recognize the visual that I thought best represented what the market was doing.
My ‘Hanging in There’ kitten.
Hanging in There!
Well the obvious happened. Slowly at first for the months of June and into July, and finally with a selling crescendo being reached at the end of August; the S&P/TSX Composite traded from EBV+2 to EBV+1.
Here is a look at what occurred in the aforementioned months and where we are now:
S&P/TSX Composite Index with weekly price bars and EBV Lines
As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the S&P/TSX Composite Index itself), so we can see where the market – S&P/TSX Composite – is trading relative to its EBV lines.
For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.
Canada can be viewed in two different ways economically or better still a two-legged stool. The first is an energy/commodity superpower, largely represented by the western provinces of the country. The second is manufacturing and processing plants that export goods to the United States, located principally in southern Ontario and Quebec. Over the last 10 plus years, and with economic expansion in China, Canada’s energy/commodity sectors have not only driven economic growth in Canada, especially since the financial crash of 2008-09, but also made the country a darling of the hot-money hedge and sovereign wealth crowd driving the Canadian dollar to par with the world reserve currency – the US dollar.
With the Canadian dollar at or around par for a secular period of time Canada’s manufacturing and processing plant/equipment/infrastructure either was mothballed or worst; permanently destroyed as foreign companies pulled branch plants and relocated them back in the United States or built new facilities in countries such as Mexico.
Well, I don’t need to tell you what has happen to the worldwide commodity cycle in the last 12 months – hint: Commodity prices go down day after day. And that giant sucking sound you hear is all that hot money, that has been so favourable to Canada over the last ten years, leaving Canada in record amounts over relatively short period of time, resulting – not surprisingly – in the Canadian dollar selling off to the $0.77 dollar level relative to the US dollar.
So our exporters should be cheering, right? Unfortunately, little is left to export as worldwide commodity prices hit record lows and our export infrastructure is no where to be found.
Long story short, Canada has to rebuild. And with this in mind Canadians, especially with the help of Ontario and Quebec, have elected a new federal government – from the Conservative Party to Liberals – to spearhead efforts in this direction with new faces and emotional energy.
So the question on my mind is; at what valuation or EBV level should this rebuilding start?
My answer: At EBV or our calculated green line on our Model Price chart. This level is calculated at 10,566 as of November I that have annotated on the chart above.
Yes, that’s a full 22% lower than the S&P/TSX Composite Index close on November 5th, 2015.
Now this can happen two ways, as we all know. Fast and quick (like pulling off a Band-Aid) or slow, first with a negative transit of EBV+1 and then with a downward grinding market – picture in your mind’s eye sandpapering your floor boards by hand – until the Toronto Index settles down at our calculated EBV support level.
So am I super bearish on Canada? No I’m not. We, as a country; and I being a resident of Toronto, am bullish on what Canada has to offer in terms of future growth – albeit slow growth because of unfavourable demographics that I will blog about later – and a good place to live. I am just pointing out the obvious in that Canada or more importantly southern Ontario restructuring or a rebuilding of infrastructure will have to occur. And as I look and drive around the City of Toronto what do I see? Massive infrastructure spending, both above and below ground, helping transform Toronto for the 21st century for the millennial generation.
As the hot money rolls out – if there is still some left – Canada needs to get cheap enough where the smart money can invest in an undervalued currency and assets – assets whether left behind or freshly built new plant and equipment – for the next expansionary cycle sometime down the road.
In my opinion, the Canadian S&P/TSX Composite Index will seek a lower valuation level on our Model Price constructed chart featured above. This will bring this Index down another 20% or so, where I believe equity valuations, in general, will look interesting and cheap relative to global equity markets. The question, of course, will be one of timing and the speed with which said Index goes to this level.
Would I sell everything Canada and head for the hills? No, I would not. The tide, in terms of money flows, has been going out for a while but it’s not over. Selective good investments still do exist and will weather market downdrafts if they occur. Plus, having Canadian dollars invested at our EBV Level will probably look smart sometime down the road when the global money-flow tides start to reverse.