Despite a lack of tech on the TSX, experts caution against viewing Canada as the ‘anti-AI’ trade
Looking at index performance alone, the Canadian stock market has had another strong year. By Mid-November the TSX 60 had returned close to 16 per cent, compared to roughly 11 per cent on the S&P 500. That delta widens looking at the past six months as the AI trade in the US began to unravel slightly, with the TSX 60 returning about 9.5 per cent in that period to the S&P 500’s 2.8 per cent.
A cursory look at those indices might point to two markets with very different exposures to technology. The S&P 500 is roughly 37 per cent technology stocks, with other big tech names like Amazon classified in consumer discretionary as well. The TSX 60, by contrast, is only 10 per cent tech. When the tech sector wobbles, US markets feel it and it seems like Canada remains insulated. On Thursday November 5th, the S&P 500 saw its worst day of the year, losing roughly 4.2 per cent. On the same day, the TSX 60 lost two per cent of its value, less than half of the losses seen in US stocks.
The question for investors and advisors, therefore, is whether recent outperformance, less tech exposure, and a higher concentration in more ‘value’ oriented equities in financials, energy, and materials makes Canadian stocks an effective hedge against the AI trade that has dominated equity markets.
“The important piece to understand is that Canada might be a hedge against AI stocks getting cheaper. It is not a hedge against AI spending slowing down. And those two aspects are really important to distinguish and understand,” says Dylan Bredo CFA, MBA, Partner at Bilyk Financial in Edmonton. “Whether Canada is a good place to get protection depends on whether we’re seeing a change in investor expectations or a fundamental change in AI investment.”
Where Canada is, and isn’t, exposed to AI
Fundamental to Bredo’s view is the distinction between AI as an investment theme that has buoyed the share prices of the world’s largest technology companies and the AI infrastructure buildout as an economic force. He notes that he doesn’t necessarily see the AI trade coming to an end, but highlights some of the potential risks to AI-related stocks that certain Canadian names might hedge against.
Canadian companies, he says, could benefit from a shift in investor appetites from growth oriented tech stocks towards more value sectors. That drive could be motivated by the tougher earnings comparables now being set for tech companies, which might motivate investors to look for sectors and companies with more stable earnings.
If the shift in AI goes beyond stock prices and starts to touch on the massive AI infrastructure buildout, then Bredo says a lot more of the Canadian stock market could be exposed. The ongoing push towards data center construction relies on a huge amount of energy, minerals, and industrial equipment, sectors with a large amount of representation on Canadian markets. Bredo cites the example of Celestica, a Canadian-listed company that participates in a number of these areas. As the AI trade has pulled back over the past six months, the electronics manufacturer has seen its share price fall by more than thirty per cent, reflecting greater investor concerns over the AI buildout.
Garey Aitken, head of Canadian equities at Franklin Templeton's ClearBridge Investments, believes that despite some shifts in the pace of the AI infrastructure buildout resulting from recent Midterm elections, the economics of ongoing demand for AI services will result in further data center construction. Like Bredo, he notes that there are certain AI pure-play winners and losers in the Canadian market. He agrees that Canadian exposures might hedge against some of the “froth” at the top end of the US market, but that many Canadian companies are tied to AI. Moreover, a significant correction in US equities, whether as a result of the AI trade coming apart or not, would have contagion effects in the Canadian market.
How to get the most out of Canada
Bredo and the team at Bilyk Financial are discretionary portfolio managers, and he argues that a stock pricking approach can achieve better targeted results than using indexes to hedge against certain market themes. He says that is more often the case during a broad rotation from growth to value, because earnings multiples are rarely the sole metric by which investors will judge value stocks. Canada offers a host of names that can work in a stock-specific approach to hedge against AI, but Bredo notes that some of those hedges can be found in the United States as well.
Aitken adds that both passive and active management strategies can play a role during a broader rotation from growth to value. The recent high concentration to “hypergrowth” names has meant active managers have generally outperformed, but he says that a broadening of performance should benefit active managers.
While recent outperformance against US indices, questions about the AI trade, and a bit of ‘elbows up’ patriotism might make some investors keen to return to the good old days of heavy home bias to Canada, Bredo cautions against going wholesale domestic again. He argues that while some of the world’s best companies are listed in Canada, many are listed elsewhere and that advisors should focus more on the resilience of the portfolios they build for clients than how geographies stack up against a particular investment theme.
Aitken characterizes Canada’s market performance as “sneaky good,” over the past several years, and its relative attractiveness compared to other regions might motivate greater investor interest. He tempers that view, however, citing the high earnings multiples in Canada’s big banks and the degree to which performance in energy stocks and mining companies has been driven by a war in the middle east and a historic run up in the price of gold.
“The question is, what do we do for an encore? I think people have to be careful, it’s not as easy as playing the winning hand that we saw more recently,” Aitken says. “I think that the worst thing for people to do would be to be making big swings with country allocations… Canada’s still got a role to play, the question of non-correlation and whether when something happens in the US you benefit from some Canadian exposure and vice versa, that’s as relevant as ever. But people should make sure they have their heads screwed on straight and not chase the last long-term winner in terms of country allocations.”
