HEWC - Franklin FTSE Canada ETF: Mixed Conditions

2023-05-11 11:06:22 ET

Summary

• Franklin FTSE Canada ETF is the most cost-efficient option in the market for those seeking exposure to Canadian stocks.
• The employment market remains sturdy, but loan growth is slowing and asset quality looks poised to deteriorate.
• The USD/CAD looks ripe for a bounce back, but Canadian stocks offer good value.

We've yet to see the impact of high-interest rates slow the labor market. - Andrew Kelvin.

Those who subscribe to content posted on the Twitter account of The Lead-Lag Report would note that I recently put out a tweet highlighting how developed markets were outperforming emerging markets, with the former’s strength relative to the S&P 500 (SP500), close to hitting 1-year highs. This recent occurrence is at odds with what you’d normally see, where both cohorts usually outperform and underperform together. I suppose it speaks to the underlying 'flight to safety' narrative that has characterized market movements off late.

Nonetheless, if you’re interested in exposing yourself to an important component of developed markets, you may consider looking at the Franklin FTSE Canada ETF ( FLCA ) which provides targeted exposure to large-and-mid-sized companies in Canada.

FLCA may only have around $300m in assets under management, or AUM, but it offers tremendous advantages on account of the superior cost differential; its expense ratio of just 0.09% is 5x lower than the iShares alternatives (EWC and HEWC), while it is also 2x cheaper than the JPMorgan BetaBuilders Canada ETF (BBCA, the Canadian-focused ETF with the largest AUM).

Switching over to the Canadian macros, I noted in the global section of this week's Lead-Lag Report how resilient the Canadian employment market has been of late. While consensus was only expecting an addition of 20000 jobs, the economy added over 2x that number at 41400 jobs. Crucially, wage growth continues to trend up nicely growing at 5% YoY.

This strong labor market will be music to the ears of Canadian banks (FLCA is dominated by financials which account for 38% of total holdings, twice as much as the next largest sector- energy) which witnessed a sequential decline in loan growth in the March quarter, driven mainly by weakness in personal lending, consumer loans, and credit card balances. Solid wage growth could also help dampen concerns over the debt servicing capabilities of Canadian households particularly as those levels are still over 180% of disposable income.

As far as credit quality goes, so far, the situation has been relatively stable on a quarter-on-quarter basis, with average provision for credit losses coming in at 22bps (as a % of total loans) yet again. However, yet still, this is expected to expand by another 12bps in the coming quarter, as the ratio moves closer to pre-COVID provision levels.

Currency shenanigans are another vital factor worth watching out for. The Canadian dollar has been benefitting from record trade surplus numbers of late, but investors also ought to consider what the respective central banks have been signaling.

A few months back the Bank of Canada became the first major central bank to resort to a pause in its tightening campaign, even as inflation continues to drop to the 4% levels from levels of 8% seen last June.

Sure, inflation may still be well above the bank’s target zone of 2% but given the high base effect that will be in play for the foreseeable future, one may be optimistic about these sequential improvements in the months ahead. It’s worth noting that the money markets are already budgeting for a 25bps cuts in rates before the end of FY23.

Meanwhile, as noted in The Lead-Lag Report, yet another solid month of job gains in the U.S. served to reinforce optimism that a potential recession may still be at least a couple of quarters away. Sure, rate hikes may not come through for the rest of 2023, but I also don’t believe the Fed is in any position to cut rates and this should provide some support to the greenback.

Crucially, while I respect that some commentators think the “death of the dollar” could be imminent, I’ve also countered that with a Twitter thread highlighting why people should not jump the gun and write it off. Whilst there are a whole host of reasons behind my relatively optimistic stance, it’s important for investors not to dismiss the dollar’s safe-haven qualities that could come in handy when debt-ceiling conflicts snowball over time. It’s worth remembering that 12 years back when we were faced with similar issues, the dollar index had made double-digit gains just before the 2011 deadline through the end of the calendar year.

Besides, if one shifts focus to the USD/CAD price movements per se, we can see that the pair recently dropped to a zone that has served as decent support since October last year. Add to that, data from the U.S. Commodity Futures Trading Commission showed that bearish bets on the Canadian dollar continue to increase week on week.

Conclusion

Relative to U.S. markets, Canadian stocks offer decent value. As per YCharts, Franklin FTSE Canada ETF trades at 13x P/E, a 30% discount to SPY’s P/E of 19x . You also get the benefit of a yield of over 2%, 60bps higher than the SPY’s corresponding figure.

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