Why the Canadian stock market's story isn't just about resources

Portfolio manager says long-term comparison with U.S. equity markets explains why macro picture favours Canada

Why the Canadian stock market's story isn't just about resources

The Canadian economy has a reputation for being highly reliant on the country's vast natural resources.

Of course, much has changed in the previous 90 years (rapid urbanization, the expansion of the manufacturing sector, the rise of the digital economy, and so on), but the truth is that resources continue to play a significant role in Canada's economy – and the same may be said for its stock market.

In a recent commentary, Mike Archibald, vice president and portfolio manager at AGF Investments, examined how the nuances of Canada’s equity market have influenced its performance compared to its North American counterpart in the U.S.

Citing Bloomberg data, he said that the combined weighting of Energy and Materials in the S&P/TSX Composite Index is close to 30%, slightly behind the Financials sector and its Big Banks. He also noted that like the rest of the world, Canada’s demographic and economic mix is always changing and evolving – which means resources don’t tell the whole story about the Canadian market’s performance.

There are some distinctions between the two major North American indices over a longer time frame stretching back to 1990, even while the TSX Composite has outpaced the benchmark S&P 500 Index in the United States on a price return basis excluding dividends over the last six months or so.

The most evident indicates, in part, that Canada's economy is still heavily reliant on natural resources.

Over the past 30-plus years, average returns in the United States have surpassed returns in Canada, with 8.5% U.S. return vs. 5.4% Canadian return, both in local currency terms --- thanks in large part to the presence of high-flying tech stocks.

Perhaps more intriguing is the fact that, in terms of both the average best-to-worst spread each year and the maximum/minimum spreads across time, the average spread of returns in Canada is substantially bigger than in the United States. Clearly, the Canadian economy's (and stock market's) resource dependence has resulted in increased sectoral volatility over time.

The AGF research demonstrates that secular growth sectors have dominated long-term returns in the United States. Industries such as information technology, followed by healthcare make up a larger portion of the S&P 500 benchmark than the TSX Composite and have dominated long-term returns in the United States, Archibald’s analysis revealed.

What impact does this have on how investors approach the two markets?

When resources are booming and secular growth sectors are consolidating, a bigger relative exposure to Canada may offer greater upside than if the opposite were the case. Those circumstances have held true so far in 2022, but investable ideas in the United States have historically provided more possibilities than the Canadian market.

That's why some investors may find a strategy that puts Canadian resource shares as a way to gain upside in a portfolio that still contains U.S. secular growth sectors useful.

Given Canada's comparatively liberal immigration laws, as well as long-tail factors like the impact of climate change on global population patterns, one could reasonably expect its consumer base – and, as a result, domestic consumption – to increase faster than in equivalent economies, Archibald said.

“Of course, Canada is not yet at the stage where it can shed its reputation as primarily a supplier of “stuff” to the world, but it might be gradually moving there,” he said. “If it does, then it will likely be an increasingly attractive destination for global dollars – and could be a solid long-term play for investors looking for areas of growth.”