Picture someone who works on mining and energy deals for a large Canadian bank. Uses a Blackberry. After work they head over to Shoppers Drug Mart or Loblaws to buy food. Then maybe to Tim Hortons for a coffee.
It’s not altogether hyperbolic to say that the above caricature basically summarizes the Toronto Stock Exchange. The TSX has mining and metals, energy and financials. Throw in some made- in- Canada retailers and two railways and that’s about it.
To be precise, financials currently account for 31.09% of the index, energy companies for 25.14%, and materials for 20.08%. So commodities plus banks and insurance companies represent a staggering 76.3% of the market.
Talk about most of the eggs in two baskets.
At the best of times, this sort of concentration would be worrisome. But now more than ever, investors should be petrified of the risks to the TSX. Both key sectors, financials and resources, face the collapse of dangerous asset bubbles likely to wreak havoc with the underlying equities.
The first bubble is the housing bubble, a bubble that everyone should be aware of, but most people are strikingly complacent about. Somehow, despite the recent housing implosion south of the border, Canadians are reasonably confident it can’t happen here.
It will, and people will be burned big time.
When housing implodes, the banks will suffer. True, their suffering may be mitigated to the extent that a good chunk of their residential mortgage business has been insured by the federal government’s housing agency, the CMHC. But the volume of business they do will drop, and there are sure to be lots of loans to housing-related industries like construction that will go bad. Many loans to over-indebted Canadians are also sure to sour.
Banks in trouble is the first part of the iceberg about to hit Canada.
The second part of the iceberg is the coming (if not already happening) bursting of the commodities bubble. So much of Canada’s recent good fortunes can be traced back to soaring prices for oil, metals and agricultural commodities. That will come to a very painful end.
If you believe Wall Street, and you really should not, commodities are sky-high because of the insatiable appetite for resources by China and India and whichever other countries a clever analyst can throw into an acronym.
In reality, commodities have soared because the relatively small resource markets, by the standards of global finance, have been deluged by a mountain of money looking for the next big thing. Hedge funds, pension funds, sovereign wealth funds, to name some of the players, have poured enough money into commodities that the true, real-world fundamentals have ceased to dictate price.
Many of the bullish bets on resources are indeed predicated on the “story” of an ever-growing China. And the problem is, that story is coming unglued. China is slowing dramatically, as an excellent recent article from the Atlantic pointed out.
Preoccupied by the goings-on in Europe, China is sure to come back on investors’ radars. And when it does, it wouldn’t be surprising if the recent weakness in commodities turns into an all-out rout.
Which means that energy and mining stocks are likely to be decimated. (Gold is not a pure commodity like the others, so I do put that in its own category). By the way, a commodities implosion will also hurt the capital markets divisions of the banks. It’s all so interconnected.
When the tech bubble burst in 2000, Canada suffered, because Nortel (and others) had such a big influence on the index. But fortuitously, a generational commodity boom started that would more than compensate.
Now, there is no obvious next bubble to save the day. If housing and commodities do what I expect, the TSX is in for the mother of all bear markets.
At least we can all still buy doughnuts at Tim Hortons.