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The question analyses the economic performance of USA and Canada in the last twenty years.

The most commonly used indicator for economic growth is Gross Domestic Production (GDP). Appendix I shows the USA GDP during the last twenty years and chart I graphically represents it.

Chart I - USA GDP

(Source: http://www.bea.doc.gov/bea/dn/gdplev.xls)

The USA economy is largest in the world. The table I shows the growth rate in 5-year phases and the overall growth rate from 1985 to 2004. The USA economy grew from $4,220 billion to $11,734 billion from 1985 to 2004 at an annualised rate of 5.5%. Additionally the annualised growth was highest in 1985-90 period and lowest was in 2000-04 period.

Table I - USA GDP growth rates

The Canadian economy is the eight largest in the world (Economist). Appendix II shows the Canadian GDP during the last twenty years and chart II graphically represents it.

Chart II - Canada GDP

The table II shows the growth rate in 5-year phases and the overall growth rate from 1985 to 2004. The Canadian economy grew from $350.7 billion to $994.1 billion from 1985 to 2004 at an annualised rate of 5.6%. This annualised growth rate is similar to 5.5% achieved by the USA economy. The main reason is that the Canadian economy is highly integrated with the economy in the US, which absorbs over 80% of its exports (Economist).

Table II - Canada GDP growth rates

Additionally the annualised growth was highest in 1985-90 and lowest in 1990-1995. Though the overall growth is same in both economies but there are intermittent periods where the growth patterns have diverged. Whereas the American economy has grown much more evenly, the growth in the Canadian economy has been more volatile. Two periods from 1985-90 and 2000-04 in the Canadian economy showed double digits growth and the growth was only 0.3% from 1990-95.

Another more meaningful parameter for measuring economy is the GDP per capita. The appendix III shows the per capita GDP from 1985 to 2003. Per capita GDP in USA was always higher than in Canada.

The table Per capita GDP of USA and Canada increased by 41% and 35% respectively. Per capita GDP of Canada as a percent of per capita GDP of USA was 88% highest in 1985 and 80% lowest in 1997. Since 1997, Canadian economy has grown faster than USA economy and the percentage has increased to 84% in 2003.

We observe the medium term patterns of USA and Canada stock indices to analyse the investment strategies for two countries. S&P 500 and S&P TSX Composite indices are used as representatives of USA and Canadian stock markets respectively.

S&P 500 index increased from 183.23 to 1203.03 between 1^st March 1985 and 28^th February 2005, an appreciation of 557% (source: Yahoo). S&P TSX index has moved from 2,625 to 9,668.32 between the same period, an increase of 268% (source: Yahoo). This shows that USA stock has given more returns in the longer run and hence investors looking for higher returns in the longer run should invest in the USA market.

Canadian economy is highly linked to the USA economy as USA buys 80% of Canadian exports. So the overall stock index movements and share price movements show similar patterns. Both indices have similar broader movements in terms of bull and bear runs.

But the markets differ in terms of volatility with USA markets more volatile than Canadian stock markets. Standard deviation of returns is used as a measure of volatility of the stock market indices. During the last twenty years, the standard deviations of daily percentage returns of S&P 500 and S&P TSX Composite are 1.077% and 0.863% respectively. So investors using financial products like options which are dependent upon volatility should prefer USA market over the Canadian stock market.

Though USA stock markets had higher returns and volatility, it is also important to look at returns per unit risk. Investors would prefer markets which offer higher returns per unit of risk. The average daily returns for S&P 500 and S&P TSX Composite in the last twenty years were 0.043% and 0.030% respectively. The returns per unit of risk, represented by average daily returns divided by standard deviation, are 0.040 and 0.034 for S&P 500 and S&P TSX Composite respectively. So not investors will get higher returns in the USA market, they would also get higher returns per unit of risk.

But in the last ten years, the movements in the Canadian stock markets were more volatile than the USA markets. The late 1990s bull run started later in Canada but was faster and sharp as compared to the bull run in USA. Subsequent bear run in early 2000s was also sharper in Canada. Canadian economy follows USA economy and hence investors should first be invested in USA. Only when they see strong bull run in the USA, they should then invest in Canada to benefit from the higher returns in the shorter run.

Appendix I - USA GDP

(Source: http://www.bea.doc.gov/bea/dn/gdplev.xls)

Appendix II - Canada GDP

(Source: http://earthtrends.wri.org/searchable_db/index.cfm?step=countries&cID=33&theme=5&variable_id=224&action=select_years

Year 2004 figures - http://www.economist.com/countries/Canada/profile.cfm?folder=Profile-FactSheet)

Appendix III - USA and Canada per capita GDP

(Source: http://www.demographia.com/db-ppp60+.htm)

REFERENCES

Economist, http://www.economist.com/countries/Canada/profile.cfm?folder=Profile-FactSheet

Yahoo, http://finance.yahoo.com

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