Canadians tend to have a home bias, investing more in Canadian securities than American ones. While the TSX has historically underperformed compared to the S&P 500, there’s good news ahead, CIBC Asset Management’s Craig Jerusalim says: the TSX will outperform U.S. markets this year.
“Canadian equities have had a decent return this decade, with a holding period total return of approximately 60%, or 5.5% annualized,” said Jerusalim, senior portfolio manager at CIBC AM, in a Jan. 18 interview.
“That’s not bad, unless you compare with the 171% return for the S&P 500. And that gap gets even wider when you look over the past 30 years, where the TSX’s annualized return was 7.7%, versus 11.5% for the S&P 500.”
The TSX’s underperformance in the last decade compared to the S&P 500 is due to tech giants like Microsoft, Apple, Google and Amazon fuelling U.S. growth, noted Jerusalim, who co-manages the Renaissance Canadian Small-Cap Fund.
Meanwhile, the Canadian index is resource-heavy, with energy-related stocks making up 20% of the TSX, he said. And that’s before accounting for banks and construction companies indirectly exposed to the energy sector. Lacklustre growth in energy and materials have put a drag on the TSX.
But that’s all about to change.
“The super-powered tech names will be hindered by the laws of large numbers, more intense regulatory oversight, and stretched valuations, while both gold and oil prices should benefit from the U.S. dollar pausing its offence in conjunction with the Fed’s downshift in the pace of interest-rate increases,” he said.
“Alberta’s new coordinated energy policy, as well as crude by rail, have helped decrease the discount for Canadian crude. And production cuts from OPEC, Russia and Alberta should help reverse oil’s Q4 2018 slide.”
Canadian equities will also benefit this year from a valuation comparison.
“The TSX is at 14.5 times trailing price-to-earnings,” said Jerusalim. “And it’s not only trading 1.5 times cheaper than its long-term average, but it’s also trading at 1.5 times cheaper than the U.S. market. This discount is in contrast to the average premium that the TSX has historically traded at.”
He added that although investors shouldn’t rely solely on valuation when it comes to predicting future returns, “it does provide a nice buffer in the event that economic conditions take a turn for the worse.”
When it comes to growth, Jerusalim noted that U.S. equities experienced 20% earnings growth in 2018, compared to 14% for the TSX.
“The year-over-year comparison now becomes much more difficult for the U.S. and, as such, the consensus forward earnings growth outlook for the TSX outpaces the U.S. market by about 3% to 4% for 2019,” he said.
“So the TSX is currently cheaper and has superior growth prospects relative to the S&P 500.”
Finally, dividend yields could also favour the TSX, Jerusalim said. “The TSX’s incremental 1.2% yield may end up carrying a lot of weight within the context of these volatile markets.”
In sum: “From my vantage point, it appears as if the TSX is set up well to outperform U.S. markets in 2019.”
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