The S&P/TSX Composite Index has merely kept pace with the S&P 500 index so far this year, with both gaining about 15 per cent.Mark Blinch/Globe and Mail
No sign yet that the Canadian stock market’s big moment has arrived.
The great postpandemic reopening was supposed to be an ideal set-up for Canadian stocks. The emergence of inflation, meteoric global growth, a run on commodities and a rotation into value stocks all play to Canada’s strengths.
But the S&P/TSX Composite Index has merely kept pace with the S&P 500 index so far this year, with both gaining about 15 per cent.
While that’s a strong showing in under six months by any standard, after a decade of underperformance, the TSX has lots of catching up to do. And history shows the greatest stretches for Canadian stocks generally coincide with periods of elevated inflation.
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So what’s the holdup? It could simply be that these kinds of major market shifts take time to germinate, said Brian Madden, senior vice-president and portfolio manager with Toronto-based Goodreid Investment Counsel.
“If this cycle has started, and I think it has, we’re maybe in the first inning of what could be a multiyear stretch of outperformance for Canada,” Mr. Madden said. “I think we’ll see some real distance between the TSX and our friends to the south.”
The last time that could be said was through the 2000s, when China’s rise to economic superpower kept commodity prices high and Canadian resources in high demand. Between March, 1999, and June, 2008, the S&P/TSX Composite Index returned 144 per cent, while the S&P 500 gained 10 per cent.
Prior to that, you need to go back to the late-1970s to find a comparable performance gap, when an oil supply shock worked to Canada’s benefit.
“Of course, it matters a lot why inflation is running hot, and if it will persist,” Robert Kavcic, senior economist at Bank of Montreal, said in a research note. “The current situation, where demand and supply are shocked in various ways by the pandemic, is a little trickier.”
The nature of the recent spike in inflation is a matter of heated debate in financial circles, especially after U.S. core inflation for May came in at 3.8-per-cent over the prior year – the biggest jump in nearly 30 years.
Central bankers have repeatedly assured investors that these readings are a temporary byproduct of a unique time in economic history.
“However, lurking in the background is a more fundamental concern that the pandemic will spell the end of the low inflation era of the past 30 years and mark the start of a period of structurally higher inflation over the medium term,” Neil Shearing, chief economist of Capital Economics, said in a note.
That scenario would deliver a clear blow to the bull run in U.S. stocks, which is largely predicated on Big Tech and growth names. If higher interest rates were required to tame inflation, lofty U.S. valuations would quickly come into question, said Stephen Takacsy, chief executive at Montreal-based Lester Asset Management.
“High-growth stocks, where earnings are way off in the distance, if there are any earnings at all, would be punished,” Mr. Takacsy said.
The TSX, on the other hand, is not exactly a growth investor’s paradise. A jump in interest rates would be good for bank profits. And inflation plays to Canada’s resource concentration, if somewhat less so than in previous cycles.
Over the past decade, the materials sector’s weighting on the S&P/TSX Composite Index has dropped from 21 per cent to 12 per cent. Over the same time, the energy sector has fallen from a 27-per-cent weighting to 13 per cent, and is now largely populated by pipelines and midstream names, rather than exploration and production companies.
That’s one reason Canadian energy stocks haven’t kept pace with the recent gains in crude prices, which has seen West Texas Intermediate rise to roughly US$72 a barrel for the first time since October, 2018. Pipelines don’t have as much direct commodity price exposure as E&Ps.
“I do think Canada will outperform the U.S. on this inflation impulse, but I think it will be less marked than it has been in prior cycles because we’ve hollowed out these sectors,” Mr. Madden said.
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