Not since the early days of the last commodity supercycle have Canadian stocks been this well positioned relative to U.S. stocks.Tijana Martin/The Canadian Press
The Canadian stock market is about to wrap up its best year in nearly two decades, by one extremely important measure.
To be clear, it was a pretty rotten year for Canadian investors. Nearly two-thirds of the companies in the S&P/TSX Composite Index are down on the year. The benchmark index has declined by 8.2 per cent – it’s worst showing since 2018. And unless you were heavily invested in oil and gas, chances are your domestic stock holdings did considerably worse than that. Add in the sell-off in the bond market and there’s not much to be happy about.
That is, until you look at U.S. stocks, which are nursing far steeper losses, with the S&P 500 index down by 19.2 per cent. Not since 2005 has the TSX outperformed its U.S. counterpart by a margin that wide. It’s an even bigger gap against the Nasdaq Composite Index, meanwhile, which has lost 33 per cent on the year.
There’s no point in denying there is a kind of petty satisfaction in beating the Americans. Here’s to repeating the hollow victory in 2023. There’s a decent chance of it.
The current economic backdrop, while unpleasant in certain ways, actually plays pretty well to the strengths of the Canadian market.
The first and most obvious reason is resource concentration. Commodity prices have backed off this year as the likelihood of a recession has grown, but they are still higher than almost any other point of the decade up to 2022.
The continuing global supply constraints and the messy geopolitics surrounding Russia’s war in Ukraine should keep upward pressure on the commodity complex.
The clear beneficiary of that dynamic so far has been the energy sector. The oil and gas names within the S&P/TSX Composite have collectively gained nearly 50 per cent in 2022.
Canada’s miners may start to contribute more to TSX performance in the years ahead. “Usually, in a recession, mining activity takes a hit,” said Jimmy Jean, chief economist at Desjardins Group. “That might be different this time around because of the sheer demand for mining products to accompany the energy transition.”
The second big force working in Canada’s favour is inflation. The TSX has traditionally served as a much better hedge against rising prices than the U.S. stock market.
A National Bank Financial report from last year found that in the past half-century, when inflation exceeds 4 per cent, the Canadian benchmark index outperforms the S&P 500 index by an average of 8.2 percentage points a year.
Let’s say, however, that the campaign to conquer inflation succeeds and price growth returns to a normal range. Does this relegate the TSX to perennial underperformer once again? Probably not, according to Canaccord Genuity portfolio strategist Martin Roberge. Canadian equity valuations are still steeply discounted against U.S. stocks. And until that gap narrows, the TSX probably has the better prospects, he said in a recent note.
A sustained period of superior TSX performance wouldn’t be unheard of, but it’s been a while. In the commodity supercycle years through the 2000s, Canadian stocks were the better performer in eight of 10 calendar years.
The script flipped in the years after the global financial crisis. Ultra-stimulative monetary policy and near zero inflation ushered in an era of U.S. stock domination. In 10 of the last 11 calendar years, S&P 500 returns outshone TSX returns, typically by a pretty big margin.
A hypothetical investor who put $10,000 in local currency into each index at the start of the period would have seen his U.S. investment grow to about $38,000 compared with just $16,000 in the Canadian index, before dividends.
Some strategists are calling 2022 the start of a new winning streak for the TSX, and the chance for investors to make up some of that lost ground.
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