by Mike Archibald, CFA®, CMT, CAIA, VP & Portfolio Manager, AGF Investments Inc.
The Canadian stock market enjoyed a good start to the year, as the S&P/TSX Composite Index rose about 6% in the first quarter. True, that performance might pale in comparison to the U.S. equity market, where the S&P 500 Index extended its late-2023 rally. But Canadian stocks’ solid gains so far in 2024 should not be overlooked, as there is reason to believe the market may gain momentum in the months ahead.
As much as investors in Canadian equities aren’t likely to complain about a 5%-plus quarterly gain, they still might look in envy at U.S. markets, where the S&P 500 rose by about 10% in the first quarter, clearly outperforming the Canadian index. There are some pretty clear reasons for the disparity. One is that the S&P 500 is about 30% weighted in technology, including trendy artificial intelligence (AI) stocks, but technology comprises less than 10% of the Canadian index, which is dominated by financial and natural resource companies. As well, on a macro level, higher interest rates have slowed Canada’s GDP growth (~1% in Q4 2023) more dramatically than in the U.S. (3.4% GDP growth in Q4), and a high proportion of S&P/TSX equities, especially financials, are correlated with economic growth. Given those headwinds, the Canadian market’s steady performance so far this year is remarkable in its own right.
Yet the winds may be turning more favorably. Economically, one factor in Canada’s favour is its strong demographic profile. For the past several years, Canada has enjoyed the highest population growth of any developed country, which should provide a boost to economic growth. The challenge is that productivity continues to lag other countries, but that may change once the hangover effects of the COVID-19 pandemic dissipate. Over the medium term – say, the next two to three years –there is a good catch-up story to be told in terms of Canadian economic growth vis-à-vis the U.S.
In the shorter term, the Canadian interest rate environment may become more benign more quickly than many currently expect. It’s a popular assumption that the Bank of Canada will likely move in lockstep with the U.S. Federal Reserve on easing, and markets have priced in approximately the same number of cuts from both central banks this year. But inflation has come down much further and faster in Canada than in the U.S. Along with a more rapidly slowing economy, lower inflation could give Canada’s central bank more leeway to cut sooner than its counterpart in Washington, which would help allay recessionary fears and provide a potential boost to financials.
On the other side of the growth/recession coin, there are strong indications that the macroeconomic backdrop is shifting from a strong growth/falling inflation dynamic (a “goldilocks” environment) to one in which growth remains strong but inflation may stay elevated, and perhaps even rise further. This reflationary dynamic, which is developing in particular in the U.S., has already driven up prices for oil, gold and copper, and is boosting commodity stocks as well. Commodities can provide a potential inflation hedge, and energy and materials – both heavyweights in the Canadian equity market – could outperform in a reflationary environment. So, too, could banks.
Structural changes in the energy sector provide another potential tailwind for Canadian equities. Canada’s oil-and-gas producers have long been constrained by limited access to global markets, but that is about to change. The Trans Mountain Pipeline Expansion (TMX) is poised to begin commercial operation this spring, and it may increase export of Canadian heavy oil to U.S. and Asian markets by potentially hundreds of thousands of barrels. That could shrink the historical differential between Canadian and global oil prices. Further down the road, LNG Canada, a liquefied natural gas export facility in B.C. scheduled to come online in mid-2025, could provide a similar boost for Canadian natural gas producers. It’s worth noting, too, that these developments are unfolding amid already-resilient global energy prices, and the fact that Canadian producers are practicing better fiscal discipline than they perhaps have traditionally is a further structural support.
Given all those factors, there’s a case for optimism on Canadian equities going forward. A lot has to go right for this short-term trend to turn into something with more duration and certainly there are risks on the horizon which could challenge this thesis: inflation may prove sticky and limit the Bank of Canada’s ability to cut rates; and new energy infrastructure like TMX and LNG are big, complex projects, and their long-term impact is still unclear. Still, one doesn’t have to squint too hard to see the potential for an already solid year for Canadian equities to get even better. In the short to medium term, their performance just might go from “good” to “great.”
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
Commentary and data sourced from Bloomberg, Reuters and other news sources unless otherwise noted. The commentaries contained herein are provided as a general source of information based on information available as of April 16, 2024 and are not intended to be comprehensive investment advice applicable to the circumstances of the individual. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained here.
This document may contain forward-looking information that reflects our current expectations or forecasts of future events. Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein.
For Canadian investors: Commissions, trailing commissions, management fees and expenses all may be associated with investment fund investments. Please read the prospectus before investing. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The term AGF Investments may refer to one or more of these subsidiaries or to all of them jointly. This term is used for convenience and does not precisely describe any of the separate companies, each of which manages its own affairs. AGF Investments entities only provide investment advisory services or offers investment funds in the jurisdiction where such firm, individuals and/or product is registered or authorized to provide such services.
® ™ The “AGF” logo and all associated trademarks are registered trademarks or trademarks of AGF Management Limited
RO:20240418-3520296
Copyright © AGF Investments Inc.
