Captured by Keeleigh
While U.S. equity markets have hit all-time highs this year, the TSX Composite Index has posted relatively modest gains by comparison. Michael O’Brien, Managing Director and Head of the Canadian Core Equity Team at TD Asset Management, discusses the performance gap and the Outlook for Canadian stocks.
Transcription
Greg Bonnell – While U.S. markets have hit new highs this year, the modest gains in the TSX Composite Index seem a little timid in comparison. Michael O’Brien, Managing Director and Head of the Canadian Core Equity Team at TD Asset Management, joins us to discuss it all. We’re excited to have you back on the show.
Michael O’Brien – It’s great to be here, it’s always fun.
Greg Bonnell – You and I were talking before the show, and all you have to do is stop a chart, where you look at the S&P 500, the rally it’s had to new records this year, and then you overlay the TSX Composite Index, and I think the term you used is sleepy. What’s going on here?
Michael O’Brien – Well, I think the first thing to say is that the TSX is not having a bad year. It’s having an average year. We’re about halfway through, I guess, tomorrow. Total return – the TSX is up about 5%. That’s a pretty average year. The problem is that we’re being compared to the superstar next door. It’s like I’m a high school quarterback, and everyone’s looking at me, and then they’re looking over the field, and there’s Tom Brady throwing spirals. It’s pretty tough to compete. So it’s not really a question of what’s wrong in Canada. It’s pretty fucked up, everything seems to be going great in the States.
But even there, the market is not very large. It’s just a number of very large, impressive companies that have captured people’s imagination. The first thing is that Canada is not really having a terrible year. We’re having an average year. It’s just very difficult to compare.
As to why we are not doing better, that is a good question, because the Bank of Canada became the first G7 central bank to cut rates. One would have hoped that would have been a catalyst. If you look at conventional valuation measures, this is not an expensive market. The dividend yield is attractive. Most of the largest sectors are trading at very reasonable valuations. So one would have hoped that would have been a catalyst.
The two things I would like to highlight are simply the issue of sentiment. I think the fascination with the Magnificent Seven, the NASDAQ, the hype around artificial intelligence, all of that sucks all the oxygen out of the room. And it’s not just in Canada. In many other markets, it’s just hard to get attention when everyone is so captivated by it.
The other side of the question, which is more of a self-help issue, is that the Canadian economy is going through a difficult period. You can’t expect people to be really enthusiastic about Canada if economic growth is below average, if earnings growth is not terribly exciting in the short term. And let’s be honest, the business climate in general… investors are not really impressed with what they’re hearing about Canada these days. It’s not the most investor-friendly part of the world right now. So I think all of those factors are holding us back. We can argue about why some or all of those things will change over time, but I think…
Greg Bonnell – This would be the next step.
Michael O’Brien – …here and now, I think that’s the problem. The feeling here is bad. And the neighbor to the south is sucking all the oxygen out of the room right now.
Greg Bonnell – Yeah, because you’re talking about being outperformed by the Americans – we’re not having a bad run here, but we’re being overshadowed – what could lead us to maybe even outperform in the years to come?
Michael O’Brien – In the short term, valuations are not always the best ally in determining when to buy or sell a stock or security. In the long term, valuations are almost all that matters. From that perspective, Canada has a glass-half-full view of the situation, that is, expectations are not overly exuberant. Over time, if the Canadian economy resumes growth, if the population continues to grow, if the central bank manages to reduce rates over the next few years, I think there are reasons to be optimistic.
But it’s just here and now, we have to deal with these issues. So I think the first step was the central bank’s policy rate cut, which is very significant. It was only 25 basis points.
Greg Bonnell – Should we see more? It’s one thing to say we’ve cut rates, but why don’t those yields look more attractive on the big blue chip stocks? It’s like, well, there’s only been one cut.
Michael O’Brien – Yes. Going from 5% to 4.75% is not going to change the investment decision of many businesses. It is not going to change the situation of many households in terms of their ability to pay their next mortgage. What is needed is to follow through. If we get two, three, four more rate cuts between now and the end of the year or early 2025, that will go a long way to putting the brakes on the economy and perhaps even starting the recovery process.
Along the same lines, you have to think about the largest group of stocks on the TSX, the Canadian banks. We’re in a period of below-average earnings growth for the banks right now, because we’re largely in a credit cycle where provisions for credit losses have been steadily increasing quarter after quarter. The underlying business — there’s reason to be optimistic over the last earnings season. The underlying business trends are improving. However, the loan losses are pretty crushing for the larger companies. We need to see that trend reverse, which is what you would expect if the economy starts to stabilize and improve.
And then beyond that, I think there are a number of niches in the market, and we can reach them, where I think some self-help is needed, where they need to do some internal repairs. But if they can do that, then there’s a good case to be made that over the next three to five years, these companies are going to be very successful.
Greg Bonnell – I think about the materials sector, which is obviously a big part of the market. You talk about the financials, which are the heavyweights in the TSX Composite Index, but energy and materials round out the top three. We keep hearing that the world is going to need more uranium, more oil, more metals to make electric vehicles. And Canadians will say, “Don’t we have these things? Why aren’t we getting them?”
Well, you know what it is, look, that’s the one bright spot – or not the only bright spot. That’s the biggest bright spot for the Canadian economy and the Canadian market today, is that the resource economy is very healthy and you have to pick your feedstocks. They’re either strong or downright strong. Oil is doing well at $80 WTI. Canadian producers are doing very well. Natural gas prices haven’t moved much here and now, but everybody can see, with LNG Canada coming in by the end of the year, much better days for natural gas. So there’s a lot of optimism about that.
There’s a lot of excitement around metals like copper and the role they’re going to play in electrification and building AI data centres. So there’s a lot of optimism around copper. Gold – it’s pretty hard to be negative on gold when it’s $2,300 to $2,400 an ounce. So that’s a good outlook. You mentioned uranium. Canada – one of the very first producers of uranium. They’re also disproportionately distributed in the West. So I think it’s a good time to be a Western Canadian when you think about the resource-based economy.
So that’s the least of our problems. In fact, it’s actually a positive. Whether you look at energy names or materials names, they’ve performed well, generally speaking, so far this year.
Greg Bonnell – In the longer term, how should we view the Canadian market?
Michael O’Brien – Longer term, the Canadian stock market is largely a reflection of the economy and the operating environment for all of these companies. If you believe, as I do, that over time Canada, as a whole, will make the right decisions and companies will make the right decisions, I think we have a great starting point. Our market is not expensive. A lot of traditional cyclical industries are coming out of a difficult period or starting to recover.
I think if we can improve the business climate here a little bit and if we can see some evidence that the rate cuts that have started and hopefully will continue to happen will lead to a reacceleration of the economy toward 2025, I think the Canadian economy and the Canadian market as a whole look very strong, especially considering that some of the big sectors have been punching below their weight for some time. The Canadian banks have not done much for investors over the last four or five years, which is very unusual if you look at history. So I think that’s a great example of what happens once we turn the corner, if there’s conviction and faith that we’re going to turn the corner, then we’re looking at much brighter days ahead.
