In hindsight, May of 2011 was the post-crisis watershed moment when market trends turned negative and the domestic equity market's long term performance advantage over the S&P 500 began to evaporate.
Now, with China's economy slowing, commodity prices falling and the Canadian dollar under severe pressure relative to the greenback, the adverse trends in the domestic equity market appear to be intensifying. Canadian investors should aggressively move portfolio assets out of domestic equities and into stable S&P 500 stocks.
The chart below, which compares the 10-year returns from $1,000 (Canadian) invested in each of the S&P/TSX and the S&P 500, shows the change in trend. From September, 2004, to May, 2011, the Canadian market outperformed significantly. On May 30, 2011, the TSX investment was worth $1,663 and the S&P 500 position was actually under water (less than $1,000) by almost 10 per cent.
From there, everything changed. Between May, 2011, and now, the S&P 500 has outperformed the S&P/TSX composite by more than 50 per cent in Canadian dollar terms.
A look at the best and worst performing S&P 500 market sectors since our watershed moment explains why this happened. Many of the top performing sectors – biotech, health care, housewares, distillers and entertainment – were U.S. industries with little or no representation in the Canadian market. The four S&P 500 sectors with the worst performance – coal, gold miners, diversified miners and oil and gas drillers – are all areas where the Canadian market has much bigger exposure.
On Monday, China's Finance Minister Lou Jiwei made statements strongly implying that the government will not provide aggressive stimulus to the nation's economy. As a result, investors can expect further slowing of the world's second-largest economy and a continuation of resource-based weakness that is holding the Canadian equity market back.
It's not too late for Canadian investors to adapt to the new environment. With global economic growth in question, the most likely road to portfolio returns is a reduction in Canadian equity holdings in favour of less cyclical U.S. equity sectors.
Health care, which is already benefiting from the entirely predictable aging of the developed world population, is a promising option. Technology, particularly areas like cloud computing where profits are driven by secular trends, is also attractive for more risk-tolerant investors.
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