A sign board displaying Toronto Stock Exchange (TSX) stock information is seen in Toronto. The index is now less than 400 points away from its record high set in September of 2014.MARK BLINCH/Reuters
The S&P/TSX composite's double-digit rally off the December lows has been, in some respects, a very un-Canadian affair.
The index is now less than 400 points away from its record high set in September of 2014. This is despite a dimming economic backdrop, with lower oil prices weighing on investment activity while the loonie reduces the nation's collective purchasing power.
The two best-performing sectors since Dec. 15, 2014 – health care and information technology – are rarely segments of the market that inspire investors to put money to work in Canada's benchmark equity index, which is often characterized as a barbell with financials on one end, resources stocks on the other, and little in between.
Acquisitions have fuelled the outperformance of the sparsely populated health-care index. Valeant Pharmaceuticals International Inc., the dominant name in the sector, purchased gastrointestinal specialist Salix Pharmaceuticals Ltd. and has single-handedly contributed about 15 per cent of the gains in the benchmark index since mid-December.
Meanwhile, Concordia Healthcare Corp. has pulled off a transformative acquisition of its own (the bulk of Covis Pharmaceuticals Inc.'s drug portfolio), while Catamaran Corp. is set to be bought out by UnitedHealth Group Inc.
Plummeting oil prices have darkened the outlook for Canadian economic growth but have done little to dissuade investors from piling into energy stocks during West Texas intermediate's recovery to approximately $56 a barrel (U.S.) after falling to a six-year low in mid-March.
The energy sector is one of three to outperform the index as a whole since Dec. 15, advancing by more than 20 per cent.
The lacklustre rebound in Canadian financial stocks, which have risen about half as much as the benchmark index over this stretch, has prevented the S&P/TSX composite from eclipsing its Sept. 3 record close of 15,657.63.
"Financials are the most feared sector in the world," said Brian Belski, chief investment strategist at BMO Nesbitt Burns.
"In Canada, they were the easiest asset to pick on early this year, due to the consensus feeling that the nation is going to be crippled by lower oil prices."
A rise in bond yields and firming economic data would be the likely catalysts for the banks to catch a bid, according to the strategist.
Mr. Belski maintains an overweight stance on the Canadian financials; other sectors he favours are the telecoms, thanks to their dividend yields and earnings consistency, and the industrials – particularly the railways, which are the most aligned with U.S. economic activity.
These three sectors have posted the smallest percentage gains since the mid-December lows, and the meagre share-price appreciation has brought valuations for the Canadian banks in line with their American peers.
"Price-to-earnings ratios on TSX firms are now roughly the same as those on banks stateside, after being about half a turn more expensive a few months ago," wrote CIBC World Markets economist Nick Exarhos. "If investors become more confident that a bottom's been set in crude, improving sentiment on the Canadian economy could cast a light on the increased attractiveness of Toronto-listed financial institutions."
The lack of breadth in the Canadian equity rally was a concern early in the year, but this has changed as of late.
The best way to examine this is to compare the S&P/TSX composite index, in which the price changes of larger companies have a greater impact on the index, to the S&P/TSX equal-weight index, in which fluctuations of every stock have the same effect.
An investor who bought the S&P/TSX equal-weight index one year ago would be well in the red, while those who purchased the S&P/TSX composite would be sitting on a 5-per-cent gain.
This divergence indicates that bigger companies have done better than the smaller ones, sheltering the cap-weighted S&P/TSX composite index from any pain.
But since March 10, the equal-weight index has gained slightly more than the S&P/TSX composite index, suggesting that smaller companies are punching above their weight. However, a closer examination reveals that much of this new-found breadth is not diverse; rather, it is concentrated amongst junior energy companies.
Of the 63 stocks in the S&P/TSX energy index, the median stock in the top third by market capitalization has risen 11 per cent since the intermediate bottom on March 10, while the median stock in the bottom third has gained 18 per cent.
The outperformance of smaller energy companies reflects increasing risk appetite and confidence that the collapse in crude prices is fully in the rear-view mirror. When oil prices were in free fall during the fourth quarter of 2014, investors sought refuge in high-quality, large-cap names such as Suncor Energy Inc., Canadian Natural Resources Ltd. and Imperial Oil Ltd., which outperformed their peer group during this stretch until the S&P/TSX composite hit an intermediate bottom in mid-December.
This development was the primary driver of the divergence between the S&P/TSX composite and its equal-weight counterpart in 2014.
As such, the recent marginal outperformance of the equal-weight index is not indicative of a market with more legs to stand on.