One of the key concerns surrounding Canadian stock-market earnings growth is the rise of the Canadian dollar. It's an oft-repeated rule of thumb that in an export-oriented economy such as Canada's, a higher currency will hurt corporate earnings; so the question is just how much has the soaring loonie negated the economic gains - right?
Um, no.
While that rule of thumb may have held a generation or more ago, it's no longer the case. In fact, because of the shifting composition of the Canadian stock market, earnings are now far more likely to rise along with the currency than fall because of it.
THE CURRENCY TIDE HAS SHIFTED
Scotia Capital strategists Hugo Ste-Marie and Vincent Delisle wrote in a recent report that in the 1990s, the correlation between the dollar and TSX earnings was negative - earnings fell when the dollar rose, and vice versa.
But since 2000, the dollar and TSX earnings have moved in near-sync with each other - an 85-per-cent positive correlation. The dollar's 75-per-cent appreciation from 2002 to 2007 was accompanied by a 147-per-cent gain in S&P/TSX composite earnings per share.
LOOK TO COMMODITIES
The key to understanding the market's about-face in relation to the dollar is the increased link both have to commodity prices. And it's not so much about a change in the composition of the Canadian economy as in the composition of the TSX itself.
Twenty years ago, commodity stocks - energy and materials - made up 30 per cent of the old TSE 300 index, while industrial stocks accounted for nearly 15 per cent. Today, energy and materials account for nearly half the index, while industrials are a thin 6 per cent.
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The dollar's rise may be bad news for non-resource manufacturers in the industrial sector, because they're getting less money in Canadian-dollar terms for their sales that are priced in weaker foreign currencies, most notably the U.S. dollar. But their contribution to the overall S&P/TSX earnings picture is now tiny.
Meanwhile, resource producers, which now dominate the S&P/TSX, have seen their revenues improve as commodity prices have climbed.
Those same rising commodity prices are closely tied to the strong loonie - both because the gains in commodity prices are fuelled in part by a declining U.S. dollar (because commodities are priced globally in U.S. currency), and because the commodity strength buoys Canada's export values, which are dollar-positive.
The result? The rising dollar, far from being a negative on a large swath of TSX earnings, actually reflects strong pricing and heavy demand that push those earnings higher.
"In fact, we'd would view a sharp decline in the Canadian dollar as being more worrisome for Canadian earnings," the strategists said.
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Understanding the Canadian dollar: A four-part series
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