The unloved TSX

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   By Guest Blogger Ryan Lewenza

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The S&P/TSX Composite Index (TSX) is having a decent year so far, up 15.6%, including dividends. While this is pretty good, it’s lagging behind the S&P 500, which is up 19.3%. There’s no denying the TSX has lagged over the last decade. Since 2011, the TSX has been behind the S&P 500 in 12 of those 14 years, which marks one of the longest stretches of underperformance on record.

The main reason is the lack of technology in the TSX (6% weight in the TSX versus the S&P 500 at 31%) and its large commodity weighting. Resources account for roughly 30% of the TSX. With commodities being out of favour over the last decade, this has hurt its performance.

TSX Sector Composition

Source: Bloomberg, Turner Investments

Given this period of underperformance, some investors have thrown in the towel on Canadian stocks and the TSX and believe its best days are behind it. We don’t buy that.

First, I looked at returns for both the TSX and S&P 500 going back to 1930, and the S&P 500 has outperformed the TSX in 51 of the 94 years or 54% of the time. That means the TSX has outperformed the S&P 500 in 43 years of the 94 years or 46% of the time. In fact, in the last period of outperformance, which was 1999 to 2009, the TSX outperformed in 9 of those 11 years. So, there are periods when the TSX does power ahead of US stocks.

And that gets me to my second point. The TSX tends to outperform when commodities are doing well, and we believe commodities are set to rise. Commodities tend to go in 6-year cycles, and we believe we’ve started a new up cycle. Commodities also tend to do well when inflation is high, and while that’s coming down, inflation will surpass the 2% it’s averaged over the last decade.

Third is valuations, and the TSX is very cheap compared to the S&P 500. The TSX trades at 16x forward earnings and 2x price-to-book (P/B) versus the expensive S&P 500 at 23x forward earnings and 5x P/B. So, with the larger gains from the S&P 500 in recent years, it’s become expensive, especially compared to the TSX.

US and Canadian Stock P/Es

Source: Bloomberg, Turner Investments

Fourth, the earnings outlook looks pretty good for the TSX heading into 2025. The TSX is expected to see its earnings rise 13% yoy next year versus the S&P 500 at 10%. So, we have cheaper valuations and potentially higher earnings growth next year. Not a bad set up.

Finally, from a sector perspective, we’re starting to see the Canadian banks do better (Royal Bank, CIBC and National Bank are at new all-time highs), and with rates coming down they will do very well next year. Banks represent 30% of the TSX. We also see gold and resource stocks doing better so when looking at all the data, we believe the TSX is primed for better performance and returns over the next 3-5 years.

So, we’re sticking with our TSX position and see better days ahead.

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

Source: https://www.greaterfool.ca/2024/09/21/the-unloved-tsx/