Recent improvement in TSX performance might be of benefit to Canada's home-biased investors
In around a three-week period Canadian stocks have returned just shy of 7%. Given a broadly weak Canadian equity market this year so far, the run up should come as a welcome surprise to Canadian investors, who still tend to have a significant home bias in their portfolios. One advisor, though, notes that this improvement in Canadian equities is part of a wider global trend, driven more by narrative and sentiment than changing fundamentals.
Josh Sheluk, Portfolio Manager at Verecan Capital Management, explained that as much as the news of positive TSX performance should be greeted as a positive, it should be viewed in the context of global markets. Canadian equities have, so far this year, lagged their US counterparts as well as many other global markets. Moreover, even this run in Canadian equities has been outpaced by US stocks, a run driven by the apparent decline in inflation and the likely end to interest rate hiking.
“Canadian stocks are up more than 7 per cent over the past three weeks. That’s a remarkable return over a short period of time,” Sheluk says. “Relative to global markets, this rally we’ve had recently has been roughly in line. If you look over a bit of a longer-term timeframe year to date, or over the past 12 months, you’ll see Canada trail pretty significantly against global markets over that period of time.”
Canada’s relative underperformance against US markets comes down to each country’s weighting of two specific sectors: tech and finance. Sheluk explains that US markets are tech-heavy, and include some of the world’s largest tech companies which have disproportionately contributed to equity growth this year. Canada, conversely, is overweight financials. Though Canadian banks didn’t have the same full-blown crisis that American banks did earlier in 2023, they have struggled with higher deposit costs and slowing loan growth resulting from interest rate increases. On a very high level, US markets have been dragged up by tech while Canadian markets have been held back by financials.
Canada’s other overweight sector, energy, has actually outperformed the broader market year to date. While oil has traded down somewhat in recent months, Sheluk notes that Canadian equity names have held up. However, that may change as lower oil prices begin to impact valuations.
While sentiment around slowing inflation and the potential end to central bank hikes has driven this recent rally across global equities, we are now seeing signs of an economic slowdown. Sheluk notes, however, that the same predictions were being made this time last year.
Nevertheless, if more changes on labour markets we may very well see a broader economic slowdown or even a recession. In that environment Sheluk thinks it may benefit investors to look beyond their home bias. US markets, for their scale, diversity, and overall quality, tend to be better set up for recessions than the TSX. Though Sheluk notes that a recession should negatively impact any market, including the US.
In the event of a soft landing, however, the Canadian market may have more attractive valuations than its US counterpart. Sheluk again highlights that quality and diversity on US exchanges may still deliver better returns. He advocates for a diverse portfolio allocation that includes an array of global developed markets.
Sheluk emphasized that the recent run in Canadian stocks is good news and while it’s healthy to hold a globally diversified portfolio, he thinks some of Canadian investors’ home bias is justified.
“There’s a case for Canada in client portfolios at all times,” Sheluk says. “In my opinion there’s always going to be a slight bias towards Canada by Canadians. I don’t see us having only 3% of our portfolios in Canada, reflecting what it represents in global stock markets. A bit of home country bias is okay but you definitely want to maintain a strong global percentage in your portfolio at all times. In my view it comes back to diversification and quality, you get more of those two attributes outside of Canada than you do inside of Canada.”
