Why the TSX recently rallied

By Staff | June 25, 2018 | Last updated on June 25, 2018
3 min read
Securities and Exchange trending up
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The TSX was up 0.8% last week, hitting a record high and reaching beyond levels last seen early in the year.

The move was impressive considering that recent economic news, such as ongoing trade woes, isn’t cause for market enthusiasm.

“The very real escalation in trade tensions would hit Canada disproportionately hard, given its status as a small open economy tied strongly to the U.S. market,” says BMO senior economist Robert Kavcic in a weekly economics report.

Other economic data failing to move the Canadian market upward include soft housing market conditions, which are slowing credit growth “more meaningfully,” says Kavcic, “with even the closely scrutinized debt-to-disposable income ratio suggesting the era of household leveraging could well be behind us.”

Read: Equities contribute to decline in Canadians’ wealth in Q1

Further, the yield curve has flattened over the last month, “with the 10s-minus-2s spread nearing cycle lows,” he says. The combination of slow credit growth and narrow spread “does not, in theory, ring bullish for the banks,” says Kavcic, referring to the TSX’s heavy weighting in financials.

Despite such indicators, however, the TSX has jumped more than 7% since bottoming in early April, notes Kavcic. He adds that gains have been widespread.

“Half of the group—healthcare, technology, industrials, consumer discretionary and energy—has posted double-digit gains over that period,” he says.

Gains are also widespread at the individual stock level.

“The move has not been driven by any one particular company as is often the case in Canada—Suncor, TD, CN Rail and Shopify top a diverse list of biggest index-point drivers,” says Kavcic.

The reason for the positive performance is arguably that Canadian equity valuations had become too depressed heading into spring, says Kavcic, especially on a relative basis versus U.S. equities.

For example, the earnings yield in Canada recently sat a full percentage point above that of the S&P, which is “the juiciest spread in almost a decade,” says Kavcic. “So it may simply be that Canadian stocks were already on guard for cloudier economic news coming into the year.”

Read: Finding bargains in U.S. equities

Investing in equities

Escalating trade tensions are prompting some equity investors to reconsider their positioning. National Bank previously reported it was reducing equity exposure by three percentage points in favour of cash.

Read: Canadian and U.S. stocks to watch as trade heats up

In a monthly equity report, National Bank further explains: “The S&P/TSX has done well in recent months and is closing in on our year-end target of 16,700. Though a weaker Canadian dollar will buoy earnings in a number of sectors, there is a limit to what the exchange rate alone can achieve if U.S. trade policy turns more aggressive on Canadian products.”

National Bank is also modifying its sector rotation to reflect this cautious view. The bank has reduced exposure to energy, materials (except golds) and industrials, while increasing exposure to telecoms, utilities and real estate.

Read: Tilting away from cyclicals: Are we there yet?

Read the full reports from BMO and National Bank.

Advisor.ca staff

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.