First Quarter 2018

For more than a decade, we have had a preference for investing in U.S. companies over their Canadian counterparts. The United States features a stronger and more diversified economy and a vastly deeper ecosystem of public companies across all sectors. For seven of the past nine years, this has paid off as U.S. equity markets have handily outperformed Canada’s. However, with recent stock market volatility caused in part by an unstable and unpredictable White House, this does give one pause for thought.

Given our North American focus, deemphasizing the U.S. would dictate a shift back to Canadian equities. This may not be an appetizing prospect. While the Canadian economy did surprisingly well in 2017, economic growth has reversed in the early months of 2018. Steps taken by the Ontario and B.C. provincial governments to squeeze foreign investors out of their respective residential real estate markets and the fragile state of over leveraged Canadian consumers will have a dampening effect on the economy. These trends will continue to provide headwinds in the future with the Canadian government itself predicting slower growth in 2018 and 2019.

It is not only the impact of short-term adjustments such as residential real estate prices and consumer spending that diminishes our interest in investing in Canadian companies. There is a longer term factor that is of much greater concern. Over the past two decades, Canada has lagged behind the U.S. in terms of productivity growth for numerous reasons. With weaker output per worker, Canada has simply thrown more workers at the problem instead of developing a cohesive Federal Industrial strategy. Further, the lack of corporate investment in research and development and capital improvements coupled with an income tax regime that is not competitive fails to attract and motivate the best and the brightest of Canada’s future workforce.

An aging population in Canada will also weigh heavily on productivity growth, a problem that most developing countries are faced with. Further, Canada has proportionately more of its work force in the public sector, a higher unionization rate, and provides fewer incentives to entrepreneurs. To be fair, this is being offset by a fairly open policy towards immigration, with 310,000 immigrants flowing into Canada every year. On a relative basis, this is much higher than the U.S. which only admits 1.0 million immigrants a year, into a population base which is 10 times greater.

Late last year, the United States passed sweeping tax reforms, which lowered its corporate tax rate from 35% to 21%. This is now considerably below the Canadian rate of 27%. The gap on personal tax rates is even greater, again in favor of the U.S. With a high spending Federal Government already running up deficits, Canada cannot afford to match these new rates south of the border.

Canada’s two dominant export industries are oil and gas and auto manufacturing. This is not trifling, as foreign trade makes up 64% of Canada’s GDP. Both the energy and the auto industry are struggling, the former due to a lack of new pipeline access, and the latter due to demand rates that have not recovered to the levels last seen before the 2008-2009 recession. With the U.S. buying 75% of Canada’s exports, the renegotiation of the NAFTA agreement is vitally important. It is difficult to foresee how the Canadian government will be able to favorably renegotiate NAFTA given the aggressive stance on trade taken by the current U.S. administration.

All of this leads us to the conclusion that we should “stay the course” with the equity strategy that we have been following now for the past 11 years. We will continue to own Canadian companies that are leaders in their respective industries, and are competitive globally. Otherwise, we will continue to hold the majority of our equities beyond Canada in order to provide you with “best in class” exposure to leading companies, strong managements, and superior growth prospects.


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