By: Jeff Pollock
September 9, 2017
 

Following years of stagnant economic growth, Canada’s Gross Domestic Product (“GDP”) is finally starting to show signs of life. In the second quarter of this year, the economy grew by 4.5 percent on an annualized rate, its fastest pace in 6 years.

In response, the Bank of Canada surprised close to 70 percent of economists by hiking rates another 25 basis points this past Wednesday, one month earlier than many anticipated.

Amid higher rates, the loonie has reacted by appreciating 6.6 percent since the end of June from $0.77US to $0.82US today. While most of this was due to short covering, it has nevertheless been the strongest appreciation posted on record since 2003 (when our currency jumped by 8.97% against the US dollar in a single quarter).

Despite Canada’s 4.5 percent economic growth, the S&P/TSX Composite Index (“TSX”) is down 2.0 percent since the year began.

Many investors are asking, why?

The simple answer is that there isn’t much of a correlation between economic growth and market performance. In fact, there’s almost no correlation at all. The market anticipates economic growth with good accuracy well before it happens, but not the other way around.

Going back to 1980, here are some interesting numbers to think about…

  • The correlation between the TSX and Canadian GDP growth rate was a mere 0.039 (zero being no correlation at all and 1.0 being a perfect correlation).
  • In years when the GDP exceeded 4.0%, the TSX posted a loss 25% of the time in the same given year as well as in the year that followed.
  • In years when the TSX appreciated by at least 15%:
    • the GDP increased 100% of the time the next year, and
    • the GDP increased by a median 3.3% annual rate the next year.
  • The TSX and Canadian GDP were either both up or both down in the same year only 62% of the time.

An economist would be well advised to look at the stock market to help guide their forecast. For an investor, however, economic growth today doesn’t offer much assistance in speculating where the market will move next.

Our Investment Committee previously raised quite a bit of cash in anticipation of better prices that will present themselves in Q4 of this year. Since the end of June, the TSX has dropped about 200 points, or 1.3 percent. So far, we’re pleased with our decision. In the weeks that follow, we’ll be looking for opportunities with more attractive prices for our clients.

 

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