The U.S. economy is the world's brightest star. Should you avoid it?
It has become an urgent question as investors weigh the strong performance of U.S. stocks over the past several years against potential underperforming bargains elsewhere, including Canada.
It's not easy to look away from U.S. stocks, of course, given the strength of the U.S. economy. Gross domestic product is beating expectations, employment is growing and the housing market is recovering.
Things are so promising that the U.S. Federal Reserve has ended its bond-buying program and is contemplating its first interest rate hike in nearly a decade – offering a contrast to most other stimulus-driven central banks.
The U.S. dollar is reflecting these shifts. It has risen about 10 per cent against a basket of currencies since the summer, hitting a four-year high recently.
David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., agrees that the headlines look good and he suggests that stocks tapping into the U.S. consumer market should perform well.
But if you're looking for better value, he suggests focusing on Canadian stocks – even if you're not Canadian.
"Canada as a cheap source of diversification for American investors is actually more compelling now than any other time in the past five years," he said in a note. "Nothing is a no-brainer except in hindsight, but this is as close as it gets."
This is a brave call, given that Canada is struggling with lower oil prices, a weaker dollar and a potentially overvalued housing market.
While the S&P 500 snapped out of a recent near-correction to hit a record high on Monday, the S&P/TSX composite index is 6 per cent below its record high in September and is lower today than it was in 2008.
Many strategists still see the U.S. market as a natural bet among unattractive opportunities elsewhere.
Michael Hartnett, chief investment strategist at Bank of America, believes the U.S. dollar will continue to rise as the economy hits so-called "escape velocity," requiring no stimulus.
He also believes that gold falling below $1,000 (U.S.) an ounce will coincide with a "final thrust higher in stocks" as bearish investors give up.
For Mr. Rosenberg, though, the factors dragging on Canada look like the most compelling reasons to buy.
For one thing, the weaker loonie looks overdone. Canada moved back into a trade surplus in September, extending the record to six positive months in the past eight, even when commodity prices have slumped.
He believes this means the dollar is "playing its role in rebalancing the economy" and could help push Canadian economic growth above the consensus expectation of 2 per cent, annualized, in the third quarter.
Outside investors have an opportunity to grab Canadian stocks at a discount while the loonie is down. It fell below 88 cents on Monday, down from 94 cents in July.
The sale might not last much longer: Mr. Rosenberg believes that bets against the Canadian dollar have gone mainstream, suggesting the downturn is at its nadir. What's more, he estimates that the current value of the loonie is reflecting an oil price of $68 a barrel, or $9 below the current beaten-up price.
If the loonie doesn't rebound, that's fine, too. Companies that feed into the U.S. economy will benefit from rising earnings – and notice from investors. Indeed, he noted that non-resource Canadian companies have rallied 13 per cent in 2014, beating a comparable U.S. index by three percentage points.
"Remember, we are not buying the TSX in whole, but rather in part – the segments of the TSX that have exposure to the U.S. and can benefit from the prior softness in the loonie, which will be a gift that keeps on giving into 2015 long after the currency finds a bottom," Mr. Rosenberg said.
He pointed to forestry companies, auto-parts manufacturing and Canadian banks with some U.S. revenue.
However, it's going to be hard to snap investors out of their fascination with U.S. stocks right now. Last week alone, a net $17.5-billion flowed into U.S. equity funds, following $20-billion in the previous week – marking the biggest inflows in a year.
Mr. Hartnett has a name for this trend: "All aboard the USS Bull!"