TSX Underperformance

Michael Coholan - Sep 27, 2022

Posted on: November 28, 2018

  Canadian Investors are Frustrated – Here’s why, and what to do about it.
 
Before I add my own thoughts on this topic, I wanted to provide you with an excerpt from comments provided by BMO’s chief economist Douglas Porter.
The ‘frankly astonishing’ lost decade on the Toronto stock market

TSX Index, Source – Thompson One, Nov. 26, 2018
“It has truly been a lost decade for Canada’s benchmark S&P/TSX Composite Index, which cracked 15,000 in mid-2008 and now sits below that mark in late 2018. Of late, of course, Canadian stocks have been caught up in the global rout. Or, as Bank of Montreal chief economist Douglas Porter put it in a report, the TSX missed out on the U.S. stock rally earlier this year, but has “fully partic­ipated” in the selloff. But the 10-year look is nothing short of disheartening for investors as the TSX, which climbed back from the depths of the financial crisis to hit a record above 16,500 in July, only to sink again, putting us right back where we started from, to borrow from that old song. Of course, you’re sitting pretty now if you happened to invest in early 2009, but “it’s frankly astonishing that the Canadian equity market has made no net progress in more than a decade,” Mr. Porter added in an interview. “There are any number of factors behind Toronto’s weak relative performance over the past decade, but the market’s structure stands right near the top of the list - i.e., a heavy weight on commodities, which have been out of favour for much of that spell, and a feather-light weight on tech, which was the pre-October market darling,” Mr. Porter said of the TSX. “While not assigning ‘blame,’ Canada’s competitiveness position has provided little help,” he added. “Even as marginal corporate and personal income taxes have been trending lower (or plummeting in the U.S. case) in much of the rest of the world, Canada’s have been erratically drifting upward.” Which gives Finance Minister Bill Morneau a “prime opportunity” to “shift that trend” in his late November fiscal update, Mr. Por­ter said.”
Back in September I wrote about headwinds that Canada and our stock market could face over the coming months.  The main concerns I and most market followers had at the time were centered on:

  • Trade issues created by the U.S. government (a.k.a. Donald Trump)

  • TransMountain and other pipeline issues, and

  • U.S. Corporate tax cuts

Regarding Trade, while the “new” NAFTA known as the USMCA agreement has been agreed upon, Trump tariffs on Canadian steel still hinder our markets as it continues to provide uncertainty for businesses who may want to invest in Canada.  By most economists’ accounts, tariffs are NOT a productive way of managing trade disputes; in fact, most would argue that they have the effect of stifling economic growth for all parties involved.  This means that the U.S. is actually hurting itself by imposing tariffs.  By adding steel tariffs in Canada, U.S. car manufactures are seeing their cost of building cars increase.  Another example is seen with tariffs against China.  A result is that China has significantly cut back their imports of U.S. soy beans and American farmers are suffering.  In fact, according to BMO Capital Markets, “The U.S. goods deficit with China hit an all-time high of $40 bil­lion in September. Exports to China are sliding downhill, while imports are pushing new highs. China has virtually stopped buy­ing U.S. soybeans; the retaliatory tariffs (and other measures) are clearly taking a toll.

The bottom line – the impact of trade scuffles/wars on Canada (U.S. and other world markets as well) is that it continues to create uncertainty and sectors of our economy and market are suffering as a consequence.
The Pipelines issues in Canada are in the news almost daily.  As I said back in September, these are issues are complex and will not be fully resolved any time soon.  In fact, there have been even more setbacks since in Canada and the U.S. where judges in both countries have ruled against pipeline projects; specifically the Kinder Morgan project in Canada and Trump’s approval of the Keystone XL saying more environmental assessment is required.  Obviously the environment is important, but governments and stakeholders must get together and work on viable solutions now.  With a lack of pipelines, a glut of oil is being produced in Canada which is driving down the price that our producers receive to historic levels. The cost to our economy has been quoted at $80 million per day; a simply astounding number.
The bottom line – without Canadian energy companies having the ability to get their oil to foreign markets, our oil markets are imploding.  Not only this, but the price of oil is crashing as well which is adding to poor stock performance. Is it just me or is Trump and Saudi Arabia a little too chummy??
The U.S. Corporate Tax Cuts have, at least initially, helped the performance of the U.S. stock market.  As Canadian’s we were concerned that these cuts would be a potential detriment to Canada’s economy as it would effectively eliminated Canada’s corporate tax advantage.  At the time, according to the Globe and Mail, “Finance Minister Bill Morneau said he has not ruled anything out – including corporate or personal tax cuts.”  His comments come as a new report warns that recent U.S. tax cuts will have a devastating impact on the Canadian economy unless Ottawa and the provinces take action.  Well just the other day, Morneau has announced, not tax cuts per se, but tax incentives for companies who invest in growing their businesses.  This is certainly a nice win for corporations and business owners who partake in these incentives but it will also negatively impact us with increases to our fiscal deficit.
The Bottom Line – any tax relief the government plans on providing corporations, while positive, will take some time to see if it will be enough to offset other corporate disadvantages our companies face.
Conclusion – CONTINUED UNCERTAINTY!
With so much at risk for Canada and its economy, it’s no wonder our stock market (TSX Index) has been struggling as of late; see below chart, market is down about 9.4% from its recent high in July and down about 7.3% year-to-date.  Contrast this with the U.S. market (S&P 500) which is down less than 1% year-to-date.

TSX Index, Source – Thompson One, Nov. 26, 2018
The bottom line is that markets don’t like uncertainty.  In Canada, much of our economy is faced with an uncertain future.  Specifically, our energy and automotive sectors have been particularly hard hit and unless our government finds a way to work these issues out, that uncertainly won’t go away soon.
So what can we do as Canadian’s?
There are two solutions for Canadian investors:

  1. Invest more heavily in the U.S. markets – Over time, I have moved my clients to about a 50/50 split between Canadian and U.S. stocks.  As Canadian’s (not unlike most investor’s from other countries) we have a home bias.  Not surprising since we know and feel very comfortable with businesses that operate in our own back yard.  The problem is that the Canadian market has very little exposure to sectors like HealthCare, Technology, and Industrials.  If you are not invested in these sectors, you have missed out on a lot of potential positive returns.

  2. If you still prefer to stay invested predominantly in Canada, it is critical to focus your investments in sectors and stocks within our market that are drawing the most interest from investors and avoid those that are being shunned.

Trying to determine where is best to invest on a regular basis is never easy; especially since markets can change very quickly.  My clients now have access to a proprietary investment process that is designed to show me where money flows are going and more importantly, where they are leaving.  This helps me to place investments is strong growth areas and avoid sectors and stocks where investors are no longer interested. 
For more information on this or any other topic, please feel free to contact me directly.
Thanks Michael Coholan
michael.coholan@nbpcd.com