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Jun 29, 2018

Why U.S. Stocks Belong In A Canadian’s Portfolio

by Nick McCullum

Nick McCullumThe U.S. stock market is perhaps the most studied and well-documented financial market in the world. Despite this attention, many Canadian investors ignore the U.S. stock market in favor of their home market – a tendency known as home country bias. In this month’s article, we’ll discuss why it is important for Canadian investors to own U.S. stocks and the actual strategies you can use to purchase U.S. stocks for your investment account.

First, let’s discuss the relative size and global importance of both Canada and the United States. The population of Canada is approximately 36 million. The population of the United States is approximately 326 million. Similarly, Canada’s gross domestic product (GDP) is approximately US$1.5 trillion while the GDP of the United States is around US$18.6 trillion.

Depending on how you measure size, the United States is around ten times as large as Canada. In a globalized world, you should own a global market portfolio. The statistics listed above argue that you should even own more U.S. stocks – even if you live in Canada.

Size aside, there are other important benefits to allocating some of your portfolio to U.S. stocks. More specifically, the American stock market has much better diversification characteristics than its Canadian counterpart.

It is no secret that the Canadian economy (and, by extension, its stock market) is heavily concentrated in two particular industries: financials and energy. For example, consider the ten largest Canadian companies by market capitalization:

  1. Royal Bank of Canada (RY)
  2. The Toronto-Dominion Bank (TD)
  3. The Bank of Nova Scotia (BNS)
  4. Suncor Energy (SU)
  5. Canadian National Railway (CNR)
  6. Enbridge (ENB)
  7. Bank of Montreal (BMO)
  8. Brookfield Asset Management (BAM.A)
  9. Canadian Natural Resources (CNQ)
  10. Canadian Imperial Bank of Commerce (CM)

With the exception of Canadian National Railway, each of the 10 largest companies in Canada are either energy businesses or financial in nature. Make no mistake – if you’re a Canadian investor looking to bolster your exposure in either of these sectors (especially financials) then there is likely to no need to invest south of the border. Otherwise, it makes sense to consider stocks that trade on United States exchanges.

Once the decision to allocate to U.S. stocks has been made, how can you find high-quality businesses south of the border?

At Sure Dividend, we specifically look for businesses with high probabilities of paying rising dividends overtime. With this in mind, the Dividend Aristocrats Index is an excellent place to hunt for new investment ideas. The Dividend Aristocrats Index is comprised of 53 companies with 25+ years of consecutive dividend increases.

Why the Dividend Aristocrats? Well, the performance of the Dividend Aristocrats over time has been truly remarkable. Over the 10-year period ending May 31, 2018, the Dividend Aristocrats have delivered 12.0% annualized total returns. For context, the S&P 500 has delivered only 9.1% annualized total returns during the same time period. The Dividend Aristocrats have outperformed the S&P 500 by 2.9% per year over a 10-year stretch.

What’s even more remarkable is that the Dividend Aristocrats have generated this outperformance with less risk. The Dividend Aristocrats Index has had an annualized standard deviation of 14.1% over the last decade while the S&P 500’s standard deviation has been 15.0% over the same time period. The Dividend Aristocrats have also experienced much smaller drawdowns during bear markets. In 2008 – the worst of the financial crisis – the Dividend Aristocrats Index fell by 21.9% while the S&P 500 fell by 37.0%.

Importantly, the Dividend Aristocrats have a much more balanced profile than the Canadian stock market when it comes to sector diversification. In fact, the Dividend Aristocrats Index is underweight in the precise areas that the Canadian markets are overweight – making them a perfect complement to a Canadian investor’s portfolio.

In the next section of this two-part series, we examine the details of this complimentary sector diversification and explain the exact strategies that individual investors can use to gain exposure to the U.S. stock market.

This article was contributed by Nick McCullum of Sure Dividend, an investment newsletter provider aimed at helping people invest better through taking low-cost, long-term positions in individual stocks.