Why the TSX will remain a chronic underperformer

Leading investment strategist shares the fundamental flaws hampering Canadian equity growth and points to where he’d invest instead

Why the TSX will remain a chronic underperformer

If you’re hoping that Canadian equities will stop underperforming next year, Craig Fehr is here to burst your bubble.

Fehr, an investment strategies principal at Edward Jones, thinks the underlying components of the Canadian equity market aren’t likely to generate any equity upticks anytime soon. Instead, he thinks investors should look to the US, and globally to a lesser extent, to find the gains they seek.

“The TSX has been a chronic underperformer since 2016,” Fehr told WP, “And I think that's what we're set up for in 2020.” 

Though he acknowledges that markets are mean reverting, Fehr thinks only two catalysts could drive a rebound for the TSX. The first would be a surge in oil prices. The second would be a “deep breath reflex” in general capital spending. That would only come if global trade tensions, slow global growth, and slow Chinese growth have created a pent-up demand for manufactured goods. Fehr doesn’t see either of those catalysts materializing in the near future.

US production has filled the gap of OPEC supply cuts, keeping gas prices low. Chinese growth has slowed, too, reducing pressure on the demand side. Overall trade conditions are noisy but unlikely to resolve soon, too.

Without either of those catalysts, the only sector that could drive the TSX to outperform other equity markets would be a surge in financials. That, in Fehr’s mind, would require either an uptick in consumer loan demand or in financial market activity.

“While the latter could play out, it’s hard to expect a real surgeon enlightened consumer loan demand considering Canadian debt levels,” Fehr said.

Though markets are cyclical, and the underlying situation may change, Fehr think that the current sectoral arrangement of the Canadian equity markets is leaving the TSX “chronically underperforming.” He sees an index that carries too much in Oil and Gas and Financials, without carrying enough of the consumer sectors of the stock market.

“Consumer spending is 57/58 percent of Canadian GDP, and between staples and discretionary, it's less than 20 percent of the overall index,” Fehr explained.

If Canada won’t deliver next year, Fehr thinks three sectors, in the US and globally, will pay dividends. Investors should look at the consumer sector, especially offshore. This late in the economic cycle household consumption will still drive growth, ideally with a strong mix of defensive staples and riskier discretionary consumer stocks benefitting from a consumer base that’s “armed with income and armed with confidence.”

“The second one then would be a real sore spot for the TSX,” Fehr said. “That’s healthcare.”

He thinks healthcare stocks might go for a ride in 2020 in the midst of a US election where radical health policies will be bandied about. But in Fehr’s mind, that will leave some stocks undervalued, cheap buys bound to rebound when the political storms abate.

The third sector Fehr is turning to is tech. Though tech stocks have already “blown the doors off,” the sector looks to be a large component of US GDP going forward. Investors need to get exposure to this sector, and they can’t get exposure domestically. He even thinks that tech is better positioned to weather a potential downturn than at any time before.

“Businesses in an economic downturn will look to add productivity through software and automation, at a time when payrolls aren't growing as quickly,” Fehr said. “I don't want to suggest by any stretch that technology becomes this bulwark that can just weather any storm, but I think it will do better in the next economic downturn than it did in any prior economic downturn.”

Fehr may be bringing bad news for the TSX, but it’s hardly doom and gloom.

“The good news is ‘chronic underperformer’ just means smaller gains, not losses,” Fehr said. “I think that's what we're set up for in 2020.”