Canada-China Trade: TSX's Lacklustre Year Shows Canadian Economy Follows China

Posted: 03/21/2012 8:04 am Updated: 03/21/2012 8:22 am

Attention investors: as growth in China slows, the Toronto Stock Exchange may not be the wisest place to position your bets.

Despite a strong performance throughout the economic downturn, Canada’s largest stock exchange, which is heavily tied to resource-based sectors like oil and gold, has fallen behind U.S. stock markets this year.

While Canada’s S&P/TSX composite index has grown about 1.8 per cent since the start of the year, New York’s Dow Jones has seen a jump of about 6 per cent.

As BMO Capital Markets economist Robert Kavcic observed in a recent note to investors, at one point last week, the gap in year-over-year performance of the TSX and the S&P 500 was close to 20 percentage points -- the widest since 1999.

According to Kavcic, the shift is in part due to flagging Chinese demand.

“Commodity prices tend to move at the margin with the growth prospects coming out of China. By association, that has a bigger impact on Canadian stocks than on U.S. stocks,” he said in an interview.

Kavcic’s observations are a clear sign of a shift in the nature of Canada’s economy: Whereas traditionally Canada had seen its economy rise and fall in relation to the U.S., today China may be as large a factor -- or even larger.

“It’s not a direct relationship to what’s happening in China, but it’s a good indication that the TSX is more commodity-heavy and more sensitive to growth prospects,” he said.

Kavcic estimates that 60 per cent of the TSX is made up of “deep cyclical sectors” -- industries that tend to see large changes in prices -- like materials, energy and industrials, compared to 30 per cent for the New York-based S&P 500.

All of which, he says, should remind investors not to overlook opportunities south of the border.

“It’s one very good reason to keep diversification into U.S. markets in mind as Canadian investors,” he said, citing exposure to less cyclical sectors, such as defence and health care, as a particular advantage of American stocks.

“The other kicker is that you have a currency that is at or slightly above parity, too, so from a historical perspective, Canadians are getting pretty good relative value on U.S. equities right now,” he added.

CIBC World Markets economist Peter Buchanan has a similar take.

Though he maintains that concerns about the recent performance of the TSX are somewhat overblown, citing “the U.S. market’s hot performance based on the strength of the technology sector” as the primary takeaway, he concedes that Canadian stocks are particularly vulnerable to what happens in emerging markets.

And with growth in China predicted to slow to 7.5 per cent in 2012 -- the lowest rate in 22 years -- his suggestion to investors is to “not put all your eggs in one basket.”

“If you spread the risk around then you are more diversified. You are better able to withstand market turbulence,” he said.

In a report last year, TD Bank estimated that, if China’s growth were to slow only to 5 per cent per year, it would dampen Canadian real GDP growth by between one and 1.5 percentage points; meanwhile, nominal GDP growth would drop by about six percentage points, an income loss of about $100 billion.

“A hard landing in China would spark a substantial commodity correction,” the bank observed. “The analysis shows that Canada’s economic fortunes are deeply tied to developments in China.”

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  • Here are a few details of the major investment deal coming soon between Canada and China, as well as a list of what CBC chief political correspondent Terry Milewski calls a "small blizzard of incremental agreements," signed in Beijing. <em>With files from CBC</em>. (Diego Azubel-PoolGetty Images)

  • The Big One: FIPA

    Prime Minister Stephen Harper called the foreign investment promotion and protection agreement (FIPA) between Canada and China the first "comprehensive economic agreement" between the two countries. In fact, what was signed by Harper and Chinese Premier Wen Jaibao in Beijing is not the final deal, but a declaration of intent: Now it must be legally reviewed and ratified by both governments, which for Canada will mean a debate in the House of Commons. Once both countries complete this process, it will need to be formally signed to take effect. This deal will protect Canadians investing in China, as well as Chinese investors in Canada, from "discriminatory and arbitrary practices." Once in place, investors can have more confidence that rules will be enforced and valuable business deals will be subject to predictable legal practices. Harper told reporters in Beijing he "absolutely" expected that it will make a "practical difference." "The agreement does not override existing Canadian law in regard to foreign investment and foreign investment review," Harper said. "Those laws remain in place." Negotiations for this agreement took 18 years, and key players in manufacturing, mining and the financial sectors were consulted to get to this stage. It's not unusual for Canada to have this kind of an agreement with a trading partner. FIPAs are in force with 24 other countries that trade with Canada, and active negotiations are underway with 10 other countries, according to the government's announcement. (Diego Azubel-PoolGetty Images)

  • The 'Blizzard' (By Sector):

    (AP Photo/Valentina Petrova)

  • Agriculture

    - A new protocol, building on a 2010 agreement to restore Canada's market access to the Chinese market for Canadian beef following the 2003 BSE outbreak and resulting border closures, to allow industrial beef tallow (fat) to be imported for the first time in almost a decade. China used to be Canada's top export market for tallow ($31 million in 2002), and now Canada has a shot at a share of the $400 million in tallow China imports from around the world. - A memorandum of understanding (MOU) on canola research, to address a recent fungal disease in canola and rapeseed that threatens Canada's valuable trading relationship with China in canola. - On Tuesday, Chinese aquaculture feed company Tongwei announced it will increase its purchase of Canadian canola by up to $240 million per year by 2015. (DAVID BUSTON/AFP/Getty Images)

  • Natural Resources:

    - A MOU between Natural Resources Canada and the Chinese Academy of Sciences to collaborate on scientific research on sustainable development of natural resources. The government release touts benefits including new technologies for resource firms, carbon emissions reduction strategies, reduced environmental impacts and natural hazards from resource development, and new opportunities for Canadian suppliers of equipment and services. - A MOU spelling out a "framework" for Parks Canada and China's state forestry administration to collaborate and share scientific expertise in the management of national parks, natural reserves and other protected areas. The agreement includes language around ecological restoration, conservation measures for endangered wildlife, wetlands development, and the preservation of forests and wetlands. (<a href="" target="_hplink">Flickr: eleephotography</a>)

  • Energy

    - A continuation of the MOU, first signed in 2001 and renewed in 2006, on energy co-operation to "engage China on energy issues" through a Canada-China joint working group on energy co-operation, chaired by Natural Resources Canada and China's national energy administration, which is responsible for Chinese energy policy. The working group oversees joint research projects, exchange of expertise, and co-operation between energy companies in both countries, including the promotion of energy efficiency and renewables. It aims to both attract capital investment and improve market access for Canadian energy resources and technology. (MARK RALSTON/AFP/Getty Images)

  • Science and Technology

    - Approval of seven projects, valued at $10 million, under the Canada-China framework for co-operation on science and technology and innovation, including: a diagnostic kit for acute kidney injuries, a wind energy seawater desalination system, a waste heat-recovery system to help oil refineries consume less fuel, new solar cells for renewable energy panels, a real-time multi-sensor navigational tracking device for hand-held devices, a blue-green algae bloom warning system and "next generation" large-scale geographic information systems. - Two more calls for proposals, valued at $18 million ($9 million from each country) for joint research under the same framework. These proposals are for the development of "innovations with high commercial potential" in the areas of human vaccines and clean automotive transportation. The Canada-China joint committee on science and technology, made up of individuals from industry, academia and government, sets the priorities and oversees these projects. (To date, 21 projects ranging from nuclear power to AIDS drugs, to clean technologies for pulp and paper have received some $28 million in funding.) (TOSHIFUMI KITAMURA/AFP/Getty Images)

  • Education

    - A renewed MOU extending and modifying the Canada-China scholars' exchange program, which has seen 900 students travel between Canada and China since 1973. New eligibility rules and scholarships will be in place for the next round of competitions in 2012, including eight to 12 Canadian scholarships for Chinese professionals and 20 awards for Canadian university students. (<a href="" target="_hplink">Flickr: Plutor</a>)