Canadian Stocks have a lot of tailwind in their favour

Trusts like MCT may benefit from rising prices and an economic bounce back…William Heathcoat Amory

It hasn’t been an auspicious few months for equity investors. Rising inflation and instability caused by the war in Ukraine have combined to make it feel as though the best option may be to buy gold and, like Samuel Pepys all the way back in 1667, bury it somewhere in your garden for safekeeping.

Even if the impulse driving such behaviour is understandable given the circumstances, it’s not entirely warranted. The mix of inflation and political instability may harm some companies and regions but not all of them.

Firms active in the commodities, financial services, and property sectors are typically better able to manage the pressures that inflation brings by raising prices in line with currency devaluation. In some instances, like banks being able to levy higher interest rates on lending services, they may even benefit from it.

Wars do tend to last longer than we anticipate and spread in ways that are hard to predict. Nonetheless, simply having less geographic proximity to the fighting means the risk of being drawn into the conflict or impacted by its side effects is reduced. And as with higher inflation, there are companies – like energy exporters – that could stand to benefit from any shortages resulting from the conflict in Europe.

‘Canada is in something of a sweet spot in both of these areas’

Canada is in something of a sweet spot in both of these areas. The country is a net energy exporter, with substantial oil and gas reserves. It is also a major soft commodities producer, with Canadian farmers currently the world’s fourth-largest wheat exporters.

Toronto’s equity market reflects this dynamic. At the end of April the S&P/TSX Composite had a 17.6% weighting to energy companies, 13.3% to materials, and 11.6% to industrials. By comparison, the S&P 500 only had a 4.2% weighting to energy, 2.8% to materials, and 8% to industrials.

Despite these relatively large weightings towards commodities, the S&P/TSX’s largest sectoral contributor is financial services. Firms like the Royal Bank of Canada and TD Bank are among the index’s largest constituents by weighting.

These sorts of firms are not a guaranteed way of protecting your portfolio from some of the problems we face today but, when you add in the fact that Canada is geographically distant from the war in Europe, they certainly look better able to handle them than many other investment opportunities out there today.

Investors that are interested in getting some exposure to Canada may want to look at Middlefield Canadian Income (MCT). The trust invests in Canadian companies, with the objective of delivering a high level of dividends to shareholders, along with long-term capital growth.

MCT’s income objective means that it tends to have a bias towards value and cyclical stocks, something that is likely to appeal to investors at the moment, particularly if inflation ends up being a longer lasting phenomenon than most of us are hoping for.

The portfolio is currently overweight to energy and utilities companies, both of which support the trust’s income objectives but also look able to take advantage of rising commodities prices and manage the effects of inflation.

The trust also has a large exposure to financials, which made up close to 25% of the portfolio at the end of March. For instance, TD Bank, Bank of Nova Scotia, and Bank of Montreal were among the five largest holdings at the end of March.

One of the added benefits of holding many of the companies in the portfolio is that they do a huge amount of business in the US. TD Bank, for example, is currently the sixth-largest bank operating in Canada’s southern neighbour.

‘In the current circumstances Canada-focused trusts like MCT may make for a very interesting option’

But even as they take advantage of the world’s largest economy, Canadian stocks tend to trade at substantially cheaper valuations than their US peers. Investors thus get exposure to the US, without having to pay US prices.

Looking forward, a couple of other tailwinds may work in MCT’s favour. One is that the Canadian economy has been slower to open up in the wake of the pandemic. Vaccine distribution took longer than in other countries, like the US or UK, which meant the economy experienced less of an economic bounce back.

That does look to be on the cards, as the country has seen close to 12 consecutive months of growth in its gross domestic product. Along with a potential boost via higher energy prices, it seems plausible this will give a lift to MCT.

Despite these positive tailwinds, the trust continues to trade at a wide discount to its net asset value. This stood at just over 12% in mid-May, after tightening from a low of close to 25% in February. This may still prove an attractive entry point for prospective investors, with the potential for additional capital growth if the discount tightens, alongside any produced by the trust’s underlying portfolio.

Again, this is not a guarantee of success. There are never any silver bullets when it comes to investing and what may be the optimal decision today might not seem like it tomorrow. Still, in the current circumstances Canada-focused trusts like MCT may make for a very interesting option.

View the latest research note on NCT here  >

_Disclaimer

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_{This is a non-independent marketing communication commissioned by Middlefield Canadian Income. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.}