It may have only been a few weeks since our last long weekend, but I’m sure that after the September we just saw, this Thanksgiving weekend is going to offer up a welcome reprieve. Markets have stabilized somewhat in the past couple of days, but there is still a high degree of unease in both bonds and stocks.  The other theme that has developed has been the performance of the Canadian equity market versus the U.S. – a topic that came up for debate in the BNN segment I appeared on this week (click here for the video).

 

 

We also covered this briefly in last night’s conference call, in the wake of this week’s relatively larger pullback in the TSX against the S&P500 and NASDAQ (playback details are at the end of the commentary). The near-3% decline in the index in the first two days of trading effectively wiped out all of the gains made this year and left the TSX down 2% since the start of January. Previous retracements, like back in last December and again in March and June of this year, failed to push down to the 19,000 level until this week.

 

 

 

 

 

In contrast, even though U.S. stocks have been bruised since July, the S&P500 and NASDAQ are still up 11% and 26%, respectively, since the start of the year. The Dow is basically flat. We have covered the reasons behind the inability of the TSX to gain transaction in 2023, from earlier weakness in energy, pressure on financials from developments south of the border and concerns about the impact that slower growth and housing malaise could have on loans. Higher bond yields have also challenged those sectors that are more interest-sensitive, like communications and utilities (especially clean-energy producers).

 

 

The view expressed by the other analyst on the program is that investors should get out of Canada and plough into the U.S. market. Ignoring the obvious points of where the value of the Canadian dollar is today and the need for diversification, it runs counter to a general desire by most Canadian investors for companies that they know and understand. This so-called “home bias” might run in the face of pure portfolio management principles, but it is a reality. For example, if we were running a portfolio like any global fund manager would, we would scarcely have 5% of it in Canadian stocks (or bonds). Again, the majority of Canadians probably wouldn’t be comfortable with such a portfolio, so the aim is to find a balance between the “bias” and a diversification strategy that resembles a global approach.

 

 

 

 

The divergence between Canada’s benchmark index and the U.S. is a relatively recent phenomenon as the above chart shows.  From 1960 to 2011, the TSX and S&P500 tracked fairly closely together with each achieving roughly a 6% average annual return during the period. Taking into account last year’s correction and the movement this year (up until last week), the average annualized return for the S&P500 is now just under 7%, compared with 5.8% for the TSX.  That may not sound like a big difference, but multiplied over 60-plus years, it adds up.

 

 

Still, the reason we diversify is to create a buffer in situations where one market goes down, in this case the U.S. From 1960 to 2022, there have been 24 years where the TSX outperformed both the Dow and S&P500.  In some cases (though not often), the TSX has actually scored a positive return while the other two were in negative territory, but in most situations the TSX either protected on the downside by not losing as much as either of the two U.S. benchmarks or it outperformed in an up year. There were two periods where the TSX had the greatest percentage of years where it was ahead – 1961 to 1973 and 1999 to 2010. Since 2010, there have been only two years where the TSX outperformed and that was 2016 and 2022 and this is why the divergence began to widen after 2010.

 

 

 

 

Typically, we think of a stock market doing better when its currency is weaker, as this would normally make that country more competitive. In fact, the relative underperformance of Canadian stocks vis a vis the U.S. has come when the U.S. dollar was weakening on the world stage. Even though the American greenback rallied during the tech bust of 2000, it peaked in 2002 and fell through to 2008. Up until this past September, the dollar was in rally mode as a result of positive interest rate differentials to its peers and a more robust economy. If, however, we are nearing the end of the tightening cycle and rates start to head lower next year, then we could see the dollar pull back.

 

 

The bigger point here is the direction of rates.  Given that a large share of the Canadian market that has underperformed in 2023 was due to higher rates and yields, I would suggest that this has created an attractive entry point into those segments, especially banks and communications. This is not to say investors should take a black and white approach, similar to the argument on the show, and move entirely back into Canadian stocks. Far from it. There are markets outside of Canada that still represent good long-term plays (such as global healthcare, technology and foreign markets like Japan).

I am even more confident in playing Canadian bonds off against the U.S. While both markets, in aggregate, have delivered similar negative total returns (4.6% for Canada and 4.1% for the U.S.), the stronger probability that growth is going to cool faster in Canada and permit a faster return to rate cuts suggests we will see slightly better performance in bonds north of the border.

 

 

As we commented on Wednesday’s call, the weeks and months ahead are likely to see further flux in the market as the market rotates between recession / soft-landing calls and rate projections get revised. It will definitely be a time to be agile and not wedded to one mantra or the other.

 

 

On behalf of the Pyle Group, have a wonderful Thanksgiving weekend.   

 

Andrew Pyle

 

Pyle Group Conference Call – Playback Details
 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. He and his clients may own securities mentioned in this column. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.