TSX finally finds love from abandoned US stock investors

Historical trends suggest the TSX should outperform the S&P 500 over the next few years

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Canadian equities have performed decently since the global financial crisis of 2008. From December 31, 2008 through the end of last year, the S&P/TSX Composite Index recorded an annualized gain of 10.1%.

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However, this pales in comparison to the performance of the S&P 500 Index, which rose at an annualized rate of 16.1%. If you had invested $1 million in the TSX at the end of 2008, your investment would have been worth $3,477,264 at the end of 2021. In comparison, the same investment in the S&P 500 index would be worth $6,873,269 $, which is an astonishing amount of $3,396,005. more than Canadian investment.

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The composition of the Canadian stock market is radically different from that of its southern neighbour. As the chart below illustrates, Canadian stocks are much more concentrated in financials, energy and materials companies, while the US market is more concentrated in the technology, healthcare and consumer sectors. discretionary.

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In 1980, country singer Johnny Lee’s song “Lookin’ for Love” was released on the Urban cowboy soundtrack. The song’s signature lyric, “Lookin’ for love in all the bad places,” is an apt description of the TSX’s underperformance against the S&P 500. When financials, energy and materials stocks outperform their technology counterparts information, health care and consumer discretionary sectors, it is very likely that the TSX will outperform the S&P 500, and vice versa.

For the two years ended December 31, 2021, the information technology sector was the best performer in both Canada and the United States. Due to the much larger weighting of technology companies in the S&P 500, their outstanding performance had a much greater impact on returns on the S&P 500 than on the TSX. Conversely, the underperformance of financials, energy and materials stocks held back the performance of Canadian equities relative to US equities.

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The following chart clearly indicates that the growth of global gross domestic product is an important determinant of the relative performance of Canadian and US equities. Stronger global GDP growth has generally coincided with an outperformance of the TSX, while weaker global GDP growth has often led to underperformance. In years when global growth was below 3.5%, Canadian equities tended to fare relatively poorly; when growth was above 3.5%, the TSX outperformed the S&P 500. Importantly, when growth exceeded 4%, ratings overwhelmingly favored Canadian equities over US equities.

The other driving factor in the competition between the TSX and the S&P 500 is oil, which is not surprising given that energy companies make up about 13.1% of the TSX compared to about 3% of the S&P 500. As As shown in the chart below, the TSX has outperformed for more than two-thirds of the years when oil is up more than 10% and has done so 80% of the time when oil is up more than 30% . Given that oil prices had been climbing rapidly even before the Russian invasion of Ukraine, they are likely to remain high for the foreseeable future.

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The TSX’s underperformance relative to the S&P 500 over the past several years has been extreme from a historical perspective. As the following chart shows, Canadian equities experienced one of their worst 10-year periods of underperformance since 2000.

Trend reversal has been one of the most defining characteristics of markets since time immemorial. Any asset class that has outperformed dramatically for many years is likely to underperform over the next few years, and vice versa. This suggests that the TSX should outperform the S&P 500 over the next few years. While historical patterns may not repeat themselves, ignoring the past is dangerous, and the graveyard of investing is littered with the bones of new paradigms. To quote investment pioneer Sir John Templeton, “The four most expensive words in the English language are ‘This time it’s different’.”

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The idea that U.S. equities are overstretched relative to their Canadian counterparts is also supported by relative valuations of the TSX and S&P 500. The following chart shows that Canadian equities are currently trading at one of their deepest discounts per relative to their US counterparts since 1994. Although relative valuations are not useful for predicting relative performance in the short term, they have always been useful for doing so in the medium to long term. The last time the TSX Composite Index traded at a significant discount to the S&P 500 for an extended period was during the tech bubble of the late 1990s, after which Canadian stocks outperformed by 28 .9% over the next five years and 83.7% over the next five years. the following 10 years.

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Mark Twain is quoted as stating that “history does not repeat itself, but it often rhymes.” From this perspective, buoyant oil prices, attractive relative valuations and the extreme underperformance of recent years are all warning signs of Canadian stock market outperformance.

Noah Solomon is Chief Investment Officer at Outcome Metric Asset Management LP.


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