The TSX may be a flop, but it is our flop.
At this point, Canadian investors may need reminding why they remain loyal to a stock market that has done little to merit loyalty.
More than a decade has passed since the heady days of the commodity supercycle, when insatiable demand for resources vaulted the TSX to global prominence.
The Canadian market has been a disappointment ever since, left in the dust of a monumental bull market that took root in the fallout of the global financial crisis and was merely interrupted by the COVID-19 pandemic.
The Canadian benchmark index has now trailed the S&P 500 in eight of the past 10 calendar years, and is well on its way to extending that bleak trend this year. Over that time, U.S. returns have outpaced Canadian by a factor of more than 2.5 to 1.
That’s a lot of money left on the table for those who lean heavily on Canadian stocks for their retirement plans.
The Canadian market is minuscule on the global scale, accounting for around 3 per cent of global market capitalization. It’s been a common argument that a truly diversified portfolio should have a similar weighting in Canadian stocks. Anything else is overconcentrated.
And yet the average Canadian with money in the stock market is heavily tilted to the TSX, with 52 per cent of their total stock holdings in domestic names, according to a Vanguard report published last July.
Why should anyone stake their financial well-being to such a perennial laggard? Well, it turns out there is strong case for investing heavily in one’s home market, even if that market happens to be the TSX.
Half of a stock portfolio in Canadian names may be a tad excessive, but it’s not far off. The Vanguard report found that the optimal weighting is about 30 per cent. Other studies have pegged that sweet spot at 40 per cent.
“Some level of home bias makes sense for Canadians since there will always be a local preference for Canadian companies and securities that are familiar and in closer proximity,” Bilal Hasanjee, senior investment strategist at Vanguard Canada, wrote in the report.
Canadians naturally have a better understanding of local companies and how they operate. And if you’re the type of investor who likes to pick stocks, you ought to have a handle on the companies in which you own shares.
Consider the banks. Most Canadians are keenly aware through firsthand experience of the dominance that the Big Six exert over the domestic banking industry. As consumers, they contribute directly to the banks’ extraordinary profitability. Why not become shareholders and tap into that earnings power?
The tax system further incentivizes Canadians to invest at home. Dividends paid by Canadian companies are given preferential treatment, whereas foreign dividends are typically subjected to withholding taxes of 10 to 15 per cent.
There are also costs to consider. Canadian fund providers typically charge much more to own and trade funds that hold foreign equities. And Canadian investors should know better than most how corrosive fees are to long-term returns because our investment fees are notoriously high.
Investing in foreign securities also introduces a level of currency risk to a portfolio. Add that all up and home bias may not be as irrational as it has long been said to be.
This unfortunately leaves Canadians heavily exposed to a stock market that has been out of favour for more than a decade.
The themes and styles that have worked best in investing in recent years are high-growth stocks, large cap-stocks, technology, and consumer discretionary names – none of which plays to Canada’s strengths.
What isn’t working so well, we have plenty of: value stocks, dividend-payers, oil and gas, and mining.
It’s a poorly diversified stock market with a nearly 60 per cent concentration in financials and resources. The tech sector, meanwhile, still makes up less than 10 per cent of the S&P/TSX Composite Index, with just four large-cap stocks to its name.
Is it any wonder why international investors have little interest in Canadian stocks?
The latest data from Statistics Canada on securities flows showed foreign investors retreating from the TSX in record numbers, with net selling of $49-billion last year.
But the TSX will have its moment once again. From a multidecade perspective, Canadian stocks have their fair share of winning streaks. The first decade of the millennium saw the TSX trounce global markets. The 1970s and 1950s were also good eras on the domestic front. All cases, it’s worth noting, were accompanied by either high inflation or high commodity prices.
On a long-enough time horizon, even bad decades smooth out. Canadian benchmark stock returns dating back to 1970 are pretty much the same as U.S. stocks have posted – in the 10- to 12-per-cent range.
There’s little choice but to stick with the TSX. It may not be the stock market we’d like, but it’s the one we’ve got.
Tim Shufelt