New Year Optimism?

The North American economies got an early Christmas present when, in uncharacteristic fashion, cooperative efforts in Washington took the debt debate off the table and pressured some high profile programmers to fix the healthcare.gov website on time. Newly appointed Federal Reserve (Fed) Chairman Janet Yellen eased into power as departing Chairman Bernanke announced the Fed’s intention to taper its’ bond purchase program. Talk about a Goldilocks scenario!

Effectively these negotiations took government wrangling off the table, which means that investors can now focus on expectations for the real economy. That’s a good thing, and something that Canadian investors have been doing for some time.

What we want to see is more signs of a real sustainable US recovery, which would benefit Canada. From two perspectives; it would help Canadian exporters and drive Canadian equities, which have underperformed the US for the past two years. Time to play catch up!

From my vantage point, I think that current bullish bias will stabilize equity markets through what looks to be a weaker first half. I say that because US consumers’ may be reluctant to spend and corporate America may be averse to hiring until both sides have a clearer understanding of the costs associated with Obamacare.

On the bright side, those costs may come in less than expected. If we draw anything from the Canadian experience, government controls will cap heath care costs which would moderate the double digit increases that currently exist in the US and ease the inflationary pressures resulting from rising interest rates. That could be very positive for stocks in the second half.

Another potential positive is North American energy independence, which is already in place. So far we have only been privy to anecdotal evidence about the long term implications, but clearly it will alter the global political landscape and more importantly provide cost effective secure energy to North American companies, which removes yet another impediment to growth.

Given this backdrop, it is likely that Canadian sectors leveraged to the US recovery will out-perform the broader US market as measured by the S&P 500 index. Front and center in this discussion are Canadian exporters, transportation companies and financial services. Enbridge, Trans Canada Pipelines, Canadian National Railway and Canadian Pacific could see decent results while Canadian banks should lead the way to recovery. Blue chip Canadian names afford a secondary advantage as rich dividend payouts provide investors with a homemade put option that can limit downside risks.

On the other hand, I am not as comfortable longer term with commodity based stocks like Agrium and Potash, energy companies such as Suncor and the gold miners particularly Barrick, Goldcorp and Agnico Eagle. Part of my concern is the lack of inflationary pressures which are key drivers for commodities, energy and most certainly precious metals.

With that in mind, you might look at buying six month or longer calls on Canadian National Railway (TSX: CNR, Friday’s close $60.08) and / or Canadian Pacific (CP, $159.45). For CNR look at the June 60 calls at $2.75 or better. With CP consider the July 160 calls at $10 or better.