All Canadian equity investors are faced with the dilemma of allocating their funds between domestic and U.S. stocks, no matter where they stand on the passive versus active strategy continuum. BofA Securities equity and quantitative strategist Ohsung Kwon has thankfully helped clarify the decision in a research report this week arguing that the TSX will outperform if inflation persists, and the S&P 500 will outperform when disinflationary forces take hold.
The disinflationary sentiment in the final quarter of 2023 led to the S&P 500 outperforming the S&P/TSX Composite by 16 percentage points for the year. Mr. Kwon finds this consistent with historical trends, notably from the 1970s, when the extent of inflation pressures effectively predicted the relative returns of Canadian and U.S. stocks.
The strategist believes that Canadian equities offer a hedge against the two biggest risks for global investors – inflation and geopolitics. Two of the three prolonged periods of Canadian stock outperformance in market history occurred during inflationary wartime eras - the 1940s during world war II and the 1970s when Vietnam and the Yom Kippur War reflected geopolitical crises.
Mr. Kwon has developed the Canada Cycle Indicator incorporating data that has historically predicted domestic stock outperformance of the S&P 500. These include government bond spreads, earnings revisions, consumer prices, OECD leading indicators and commodity prices.
The Canada Cycle Indicator remains depressed, in the bottom 12th percentile relative to the post-1950 average, reflecting the dramatic 2023 underperformance of domestic stocks and the near-record economic growth differential between Canada and the U.S. BofA believes commodity price strength will be needed to change the trend sustainably.
The last time domestic stocks traded at such a steep discount to the S&P 500 was early 2000, and Canadian stocks outperformed for the following decade. Mr. Kwon cites the TSX’s current 15 times forward earnings multiple as “a great entry point” for Canadian equities relative to the U.S.
The strategist expects the U.S./Canada economic growth differential to narrow in 2024 and this, combined with relative valuation levels, likely indicates the worst is over for domestic stocks when compared to the S&P 500. Beyond that, investors should watch inflation data closely, favouring domestic stocks when inflation surprises to the upside.
-- Scott Barlow, Globe and Mail market strategist
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The Rundown
This is why REITs aren’t worth buying yet
The domestic real estate investment trust sector does not yet, on average, offer enough of a yield advantage over risk-free government bonds to suggest strong returns for the coming years, according to an analysis Scott Barlow has conducted of the past 18 years of data.
Uncertainty creeps back into U.S. Treasury market after Fed, blockbuster data
A rethink on when the Federal Reserve will cut interest rates is reverberating through the fixed income market, heightening risk for those betting the explosive rally that took bonds higher at the end of 2023 will continue this year, reports Reuters.
Also see: Get used to bloated Fed balance sheet - it’s here to stay
U.S. stock buyback plans picking up in earnings season
U.S. stock buybacks are picking up, with corporate announcements this earnings season trending above the prior two quarters and above the average of the past 12 earnings periods, reports Reuters. Goldman Sachs and other strategists have projected a rebound in buybacks this year after a down 2023, which can help support the stock market in 2024.
Mergers can mean major risks for investors
Regulatory scrutiny on mergers and acquisitions is on the rise in Canada and the U.S. Philip MacKellar explains why this has major implications for corporate management teams, long-term shareholders, and merger-arbitrage investors.
Others (for subscribers)
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Number Cruncher: Eight undervalued industrial stocks to strengthen your portfolio
On Commodities: What is happening in the global wheat market?
Nvidia’s stock market value on verge of overtaking Amazon
Globe Advisor
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Ask Globe Investor
Question: Can you please explain why I have lost money on the TD U.S. Money Market Fund (US$)? I bought my D series units (fund code: TDB2915) with U.S. dollars from my U.S. account in three installments: US$107,540 in July, US$22,100 in October and US$92,000 in December. My statement now shows that my holdings have lost US$937.20, or 0.42 per cent, which is the difference between the “book cost” of $225,587.93 and the current market value of US$224,650.73. I thought you couldn’t lose money on a money-market fund. I have talked to four different representatives of Toronto-Dominion Bank but am still confused.
Answer: Good news: You haven’t lost money. You’ve made money.
You can confirm this by adding up your three lump-sum purchases, which total US$221,640. Now compare that with the current market value of your holdings, which is US$224,650.73. The difference of US$3,010.73 reflects the interest you have earned and reinvested in additional units of the fund, which currently yields about 5.4 per cent.
So what’s with the $937.20 loss on your statement? Why would your financial institution make it look like you’re in the red if you’ve actually made money?
This is where things get a little more complicated. You can click here for my detailed explanation.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
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Compiled by Globe Investor Staff