SHANNON STAPLETON
As the dollar appreciates, there are more articles in the financial press commenting on how U.S. stocks are becoming cheaper from the point of view of Canadian buyers. I am probably the last person from whom you should take investment advice, but there are some things to think about when you're trying to decide if a stock is cheaper or if it is simply worth less.
Buying USD-denominated assets is in large part a bet against the Canadian dollar. Since 2000, Canadians who bought the S&P500 index instead of the TSX have generally regretted it; see the accompanying graphs. The average CAD return on the TSX was 11 per cent more than the CAD return on the S&P500 over the past decade. (See here for a longer discussion that uses pre-2000 data.)
But that doesn't necessarily mean that U.S. stocks are a bad deal, because they have one very attractive property: they generate higher returns for Canadians during bad times. This is the sort of correlation that is most valued by investors: we are willing to pay extra for assets that pay off most when extra money is most needed. For example, most people buy fire insurance, even though it is a money-losing investment for almost all households. Even though the odds of a fire are small, homeowners are still willing to pay for an asset that pays off when their house burns down.
And so it is with USD-denominated assets. Although their average returns have been generally lower than Canadian assets, they have the advantage of generating higher returns -- or less bad returns -- during the bad times.
So here's what Canadian investors should be thinking about in their deliberations over whether or not to buy those USD-denominated assets:
- In the short and medium term, are you willing to bet that anticipated USD returns will be high enough to compensate for the losses generated by a possible CAD appreciation? It should be remembered that the U.S. Federal Reserve will be maintaining a very expansionary monetary policy "for an extended period", while the Bank of Canada will be starting to tighten its policy stance very soon.
- In the longer term, what is the risk premium you are willing to sacrifice in order to hold USD assets that will generate a higher return the next time a crisis rolls around?
Clearly, some individual stocks will be good investments. But as a general strategy, buying U.S. stocks involves more than looking at projected U.S. dollar-denominated rates of return. And given the outlook for the Canada-U.S. exchange rate, they deserve an even closer examination.