Oh Canada?!

RYAN  By Guest Blogger Ryan Lewenza

What’s the deal with the TSX? With the improving Canadian and global economy, rebounding corporate profits and higher commodity prices, you would think the TSX should be doing a lot better than the -5% YTD return and the 6.7% average total return over the last five years. The conditions are there for the TSX to be crushing it instead the TSX is greatly lagging the US and many other global markets. What gives?

I believe it’s all about the macro right now rather than the fundamentals, which are actually quite solid. I think global investors are avoiding Canadian stocks, despite typically positive conditions, given macro concerns like the NAFTA negotiations, our inflated housing market, and our ineffective leaders who are dragging their feet on major pro-growth projects like the much needed BC pipeline.

This can be seen in foreign investor flows, with foreign investment in Canadian assets declining materially over the last two years, from roughly $70 billion in 2013-2015 to just $40 billion in the last two years.

Annual Foreign Investment in Canada

Source: Bloomberg, Turner Investments

Another great chart that further illustrates this underperformance is to compare TSX returns relative to the world, with emerging market equity relative performance. Essentially, investing in the TSX is the same as investing in EM equities as they are plays on stronger global growth, a weaker US dollar, and higher commodity prices. Below I capture the high correlation between these two markets (relative to global equities). Note how they have closely tracked each other for years, but noticeably, have diverged recently with EM greatly outperforming the TSX over the last year. For example, EM equities were up 30% in 2017, far better than the TSX, which was up only 9%. Why is this happening?

TSX and EM Equities Relative Performance

Source: Bloomberg, Turner Investments

I believe it’s a mix of internal and external forces that is causing this TSX underperformance. Specifically, I believe the ongoing NAFTA negotiations (external event) and the anti-global trade sentiment emanating from 1600 Pennsylvania Ave are causing investors to look elsewhere for their commodity exposure. Note how the divergence with EM equities started in early 2017 when Trump took over as Commander-in-Chief. Investors are connecting the dots that if President Trump rips up NAFTA then Canada’s going to clearly be impacted from this given our high reliance on trade with the US.

But it’s not just NAFTA. I believe our own internal dysfunction and misplaced government priorities are weighing on our economy and markets. Here I’m talking about the current anti-business, misdirected pro-spending policies coming from the provincial and federal governments.

In BC, the NDP government is trying to torpedo the housing market, blow up the Kinder Morgan Trans Mountain pipeline expansion, and only reluctantly approved the massive Site C Dam project. Our Federal government is dragging its heels on much needed infrastructure, is not pushing hard enough on the BC pipeline expansion, while our PM seems more preoccupied with photo-ops and wearing the most fashionable Indian garb while on unproductive state visits. And don’t even get me started on Kathleen Wynne and her blatant attempt to buy votes in the upcoming Ontario provincial election.

For me the BC pipeline is emblematic of everything wrong with our current leaders and their priorities. This is a layup and they can’t even get this one right. Global oil demand is close to hitting a new all-time high of a 100 million bls/day in 2018, while Canada ranks third in the world for oil reserves.

So we know there’s lots of demand for our oil, but due to our dysfunction and lack of leadership, we’re failing to ship this oil to new markets. And this has major consequences for our economy, as perfectly captured in the massive discount of our oil price (Western Canadian Select) to US (West Texas Intermediate) and global (Brent). Below I show this discount, which currently sits near a record high of US$25/bbl relative to WTI. Yes we have to consider the environmental consequences and try to minimize the effects of drilling and exporting oil & gas, but this shouldn’t take precedence over jobs, economic prosperity and progress!

Canadian Oil Price Trading At a Huge Discount

Source: Bloomberg, Turner Investments

So there you have it. The TSX can and should be doing better, but it’s going to require our leaders to get to work and resolve some of these major impediments to economic growth.

Thankfully we’re hearing great progress is being made on NAFTA with some speculating a deal is just a month or two away. Let’s get this resolved and then have our leaders zero-in on the BC pipeline and many other needed infrastructure projects which will help stimulate economic growth, increase productivity, and help address our lagging stock market.

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.