Global Equity Weekly

March 01, 2024 | 16:31

Did the Bull Leave Canada Behind?

Economist

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Robert Kavcic

Senior Economist and Director
Economics

Robert has been with BMO Capital Markets since 2006. He plays a key role... (Read more)

Equity markets notched further gains this week amid a mixed run of growth and inflation data. The S&P 500 rose 0.9%, led by technology and consumer discretionary. The TSX added 0.7%, with energy getting a boost from a return to $80 oil. Bank earnings results were mixed, and the sector finished the week little changed when all was said and done.

The Canadian economy continues to underperform its U.S. counterpart by a wide margin, with real GDP growth of 1% over the past year compared to about 3.2% south of the border. This, no less, comes despite the fact that Canada’s population growth has run more than 2.5 ppts stronger, leaving the rift in per capita growth at an even wider, and historic, 4.8 ppts. Interestingly, serious underperformance of Canadian equities since early 2023 has almost perfectly flagged this relative weakness in the real economy. The TSX is now up about 5% y/y, which is not bad and an encouraging sign that the economy is holding, but trails a blistering near-30% gain in the S&P 500. To be sure, there are technical factors at play driving the performance gap, but the market might also be flagging some real fundamental issues.

On the technical side, the old truth is that Canadian equity indices often just don’t have much exposure to what is working, and that couldn’t be truer today. The vast majority of the growth in the S&P 500 over the past year has been driven by 30%-to-60% surges in technology, communication services and consumer discretionary. Combined, those three sectors now make up 50% of the S&P 500, but just 17% of the TSX. In fact, just five specific names—Nvidia, Microsoft, Amazon, Meta and Apple—have alone accounted for almost half of the net 1200 point increase in the S&P 500 over the past year. Canada doesn’t have those names. At the same time, Canada carries more interest rate-sensitivity across sectors like utilities, real estate and in telecom services.

But there are also some more fundamental forces at play. While we can argue that the TSX is built with more rate sensitivity, it just so happens that Canada’s economy looks more rate sensitive as well. Consider that, while households are now in the thick of mortgage renewals into higher rates (which is crimping disposable income and discretionary spending in Canada), many U.S. households have locked in for 30 years. Even with torrid population growth, real consumer spending growth in Canada is trailing that in the U.S. by 1.5 ppts over the past year.

The profit picture has also been weaker in Canada. Nominal corporate profits in the national accounts have fallen in the past year to 6% of GDP, while they’ve held firm in the U.S., and S&P 500 earnings continued to top the expectations bar in Q1. Margins appear to be getting squeezed more in Canada, in part because unit labour costs are running hotter. While growth picked up to 6% y/y in Canada, unit labour costs have cooled to around 2% y/y in the past two quarters in the U.S. Related to that, Canada is fully missing out on the upturn in productivity growth that has caught wind south of the border, while it sees M&E investment contract. These are fundamentally important factors for equities because they drive earnings growth while also absorbing inflation, and they are right now tilted well in the U.S. direction.

That said, there’s little question that Canadian stocks have become relatively cheap. That’s good news if you believe that sentiment toward Canada is in the tank, and these factors will eventually correct themselves, allowing valuations to normalize. It’s less good news if it’s just a value trap reflecting weaker fundamentals going forward. BMO’s respected strategy team leans toward the former. Indeed, the TSX currently trades at just 14 times forward-year earnings versus 21 times for the S&P 500, about as wide a gap as we’ve seen historically (think end of the late-90s tech boom).

Where does this all leave us? Canada’s poor relative equity market performance is both technical and fundamental; but, it’s always darkest before dawn.

Major Index Performance

North American Sector Performances

(% change over period)

Table 1 - S&P 500 Sector Performance

Source: BMO Economics, Bloomberg

Table 2 - TSX Sector Performance

Source: BMO Economics, Bloomberg

TSX Relative Sector Performance

(relative to the index, year-ago = 100; dashed line = 200-day m.a.)

S&P 500 Relative Sector Performance