By: Jeff Pollock
January 15
, 2018

In 2017, the S&P/TSX Composite Index (“TSX”) posted a 6.0% price return despite topping the G-7 nations with a 3.7% average GDP growth throughout the year. While our domestic economy outpaced Canada’s peers south of the border, the TSX underperformed relative to the S&P 500.

What happened?

Canada’s economy and stock market fail to mirror one another with the same amplification for two reasons. First, the stock market’s behaviour forecasts economic conditions 6-12 months in advance. Second, Canada’s economic composition is not properly reflected by its stock market constituents.

Many rely on the economic characteristics of a country to forecast its stock market potential. However, going back to 1980, the correlation between the TSX and Canada’s GDP growth rate was a mere 0.039 (zero being no correlation at all and 1.0 being a perfect correlation). It’s not particularly all that useful.

The market often leads economic conditions well before an economist notices a change in behaviour, leaving economic data points of little or no aid to an investor. For example, while Canada led the G-7 in economic growth last year, the TSX appreciated 17.5% in price the year before, far outperforming the US market’s 9.5% in gains. If I were an economist, perhaps I would pay attention to my country’s stock market to help shape an economic outlook. But as an investor, my time is better spent assessing earnings, cash flow statements, and debt levels.

Furthermore, the composition of the TSX significantly differs from the sectoral influences that drive economic growth. 52% of the TSX is comprised of commodities and the five large banks. A large move in price from either of these two constituents will surely influence the index’s direction positively or negatively. Because of our highly concentrated exchange, we discourage investors from owning an ETF that tracks its performance.

Rather than focus too closely on present economic conditions, Vestcap’s Investment Committee continues to make its decisions based on our fundamental analysis of the stocks that show up on our valuation screens. We invest with an eye to the future and apply our contrarian approach to companies out of favour. As investor Charlie Munger once said, “microeconomics is what we do, macroeconomics is what we put up with.”

 

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