07/22/96 WILL THE BULL HEAD TO CANADA?

WILL THE BULL HEAD TO CANADA?
Canadian stocks rally as exports and commodity prices rise
Lloyd Atkinson, chief investment officer at Toronto-based MTA Investment Counsel, is used to getting a quick brush-off from foreign investors. ``Their view has been, why would anyone invest in Canadian stocks?'' he says. No wonder: Compared with U.S. stocks, Canadian equities have looked tepid. For the five years ending June 30, the benchmark Toronto Stock Exchange Composite 300 Index has earned an average annual return of 10.8% vs. 15.7% for the Standard & Poor's 500-stock index. Last year, Canadian stocks logged less than half the U.S. market's gain.
But now, with the U.S. bull market slowing, Canada is suddenly looking far more attractive. Many Canadian strategists believe rising commodity prices and a dramatic improvement in Canada's economic fundamentals should power the TSE index to a 15% to 20% gain over the coming year, well above the single-digit advances they foresee for the S&P. Canadian stocks may look even better for U.S. investors if, as expected, the Canadian dollar strengthens.
SHRINKING DEFICIT. ``The late stage [of an economic] cycle is when Canadian markets typically outperform the U.S.,'' notes George Vasic, chief strategist at Bunting Warburg Inc. That's when commodity prices are strongest. Metals, oil and gas, and other resource stocks make up about 40% of the TSE 300--over three times their weight in the S&P 500. The recent collapse in copper prices was largely the result of a trading scandal at Sumitomo Corp. ``The outlook for natural resources is bullish,'' says Patricia M. Mohr, an economist at the Bank of Nova Scotia. The Scotiabank Commodity Price Index, a measure of commodities exported from Canada, hit a record 131 in May, the latest date available, up 11.3% in a year.
Improving economic fundamentals should also help Canadian stocks. Huge cuts in government spending are shrinking the budget deficit. That has allowed the Bank of Canada to bring short-term interest rates below those in the U.S. And inflation is just 1.5% a year.
Political waters are calmer, too. Last year, worries that Quebec separatists might win the independence referendum held the TSE to a 14.5% total return. Now, with another vote at least two years off, foreign investors are coming back at a near record pace. And Canadians are piling into mutual funds. Equity fund assets climbed to a record $35 billion in May, up 33% this year. ``There's a lot more firepower available,'' says Subodh Kumar, chief strategist at CIBC Wood Gundy Securities.
Moreover, partly because Canada's economic expansion has lagged behind the U.S.'s, ``we expect substantially more earnings growth in Canada over the next two to three years,'' says Vasic. The biggest winners, adds Diane Urquhart, manager of equity research at Scotia Capital Markets, will be the world-class resource and manufacturing companies responsible for the astonishing surge in Canadian exports, which now account for fully 40% of Canada's gross domestic product (chart).
Urquhart is especially bullish on nickel giants Inco Ltd. and Falconbridge Ltd., which benefit from rising prices. Stronger pulp prices should help such forest-product companies as Abitibi-Price, figures Josef Schachter, global strategist at Richardson Greenshields. And many are bullish on midsize oil and gas companies.
Toronto has long been a magnet for gold bugs. After soaring earlier in the year, gold stocks plunged 16% in June. The sell-off was punctuated by an abrupt reversal in the speculative frenzy surrounding so-called junior mining companies, which are exploring for gold and other minerals but typically have little actual production. Most analysts expect the larger gold companies to stage another rally.
Ironically, a far bigger threat to the TSE is Wall Street. A substantial correction in the U.S. market might rattle the Canadian market. But even if that happens, ``any dip in Toronto would be less severe than the U.S.,'' predicts Kumar. With all the fundamentals pointing in the right direction, the message for investors is clear: Go north.
By William C. Symonds in Toronto