BofA Securities quantitative strategist Ohsung Kwon provided a delightful bullish case for investing in Canadian assets late last week in A New Regime: Buy Canada. In digging deeper into Mr. Kwon’s analysis, I discovered something interesting: the difference between valuations in domestic and U.S. equities doesn’t really tell us anything about future performance.
The strategist’s rationale included that the TSX 60 trades at a “historic” discount to the S&P 500, and that Canada is an exporter of the commodities that are currently globally scarce. Mr. Kwon also noted that BofA analysts have a promising outlook for Canada’s banking stocks.
Regarding the first point, BofA emphasized that the forward price to earnings ratio of the TSX 60 is 30 per cent lower than the S&P 500, a post-2000 record. Canadian large cap stocks are really, really cheap relative to U.S. stocks.
I looked at the past 21 years of index data in an attempt to uncover what this valuation discount means for Canadian versus U.S. stock performance going forward. For every month, I measured the discount or premium of the TSX 60 against the S&P 500, and the difference in index returns over the following one, three and five years.
There is no meaningful correlation between valuations and relative returns over one or three years and only a marginal connection between valuations and five year returns. Statistically speaking, the cheapness or expensiveness of the TSX 60 has little or no predictive value for future returns relative to U.S. stocks.
Mr. Kwon’s analysis is still compelling and positive for domestic equities. And it’s definitely preferable that Canadian stocks are less expensive than the S&P 500 than the reverse case.
BofA presented the valuation evidence, and the implication was obvious – more attractive valuations make outperformance more likely. In fact, that’s a hard case to prove.
Investors have to check that every reason for buying an asset has meaningful repercussions before committing capital.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Lithium Americas Corp. (LAC-T) Month-to-date, the share price of this lithium project operator has made it the worst performing stock in the S&P/TSX Materials Index. But Jennifer Dowty says this correction may soon present a buying opportunity for long-term investors. The stock has 14 buy recommendation and the average 12-month target price suggests the share price has nearly 42-per-cent upside potential.
The Rundown
Economic growth risks jolt inflation-obsessed markets
After months focusing on central banks’ response to raging inflation, financial markets are being jolted into the realization that a global economic downturn may now loom. Sentiment dampeners include the Ukraine war, huge rises in energy and metals prices, aggressive central bank policy tightening led by the U.S. Federal Reserve, and China’s policy of locking down cities to ward off COVID. And omens are flying in thick and fast, too. Investors have reacted by pushing bond yields off recent multi-year highs, driving down oil prices from 14-year peaks and dumping currencies such as the Australian dollar and Brazilian real that had, until recently, surfed the commodity boom. Are we at an inflection point? Sujata Rao and Dhara Ranasinghe explore the topic.
Also see:
‘Peak subscription’ a red flag for U.S. economy and markets
Hot job market, an economic relief, is a Wall Street worry
Inflation narrative a ‘virus’ and policy headache
Why REIT returns are set to disappoint
The last time the domestic real estate investment trust sector’s yield advantage over risk-free government bonds was this small was 2007. In that case, steep losses persisted in the following 24 months, thanks to the financial crisis. Will the average REIT drop 40 per cent in the next two years this time, as it did then? Scott Barlow doesn’t think so, but he does see reason for investor concern.
The perfect storm has arrived for stock markets. But there’s still one way to invest for big returns
David Rosenberg believes we’re seeing a perfect storm for risk assets, and he doesn’t think we’ve ever seen such a smorgasbord of downside risks all taking hold at the same time. But the economist and noted contrarian argues that investors could make out very well with bond holdings. Here’s his take on current risks and opportunities.
Tempted by Canadian bank stocks during the sell-off? It could get worse
Recession clouds are moving in and Canadian bank stocks are down, but the case for buying the dip has a serious flaw: Recessions tend to hit bank stocks a lot harder. David Berman explains.
Ether prepares for epic ‘merge’ in quest to eclipse bitcoin
Ether has promised to go to the next level, edging out crypto rivals and even outshining the godfather, bitcoin. But the clock’s ticking. The No. 2 cryptocurrency was supposed to be weeks away from the “merge”, a transformative June upgrade of its blockchain Ethereum to make it faster, cheaper and less power hungry, holding out the prospect of a meaner and cleaner crypto future. The anticipation had supported ether this year, even as inflation and monetary tightening shackled bitcoin. But that merge – which would see ether mining transition away from the energy-intensive proof-of-work method to proof-of-stake – has been delayed, frustrating investors.
Others (for subscribers)
Analysts’ forecast returns and recommendations for all stocks in the S&P/TSX Composite Index
Number Cruncher: Ten U.S. companies with a strong competitive advantage and solid earnings momentum
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Tuesday’s Insider Report: Director invests over $300,000 in this financial stock that’s rallied 55% over the past year
Globe Advisor
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Ask Globe Investor
Question: I’m 67 years old, retired, and have a self-directed RRSP, and a self-directed spousal RRSP, with the same brokerage.
My wife set up the spousal plan for me. She has not contributed to it for many years, and there are no plans to do so in the future. Both plans earn dividends and will be converted to RRIFs in the year I turn 71.
The regular RRSP earns enough dividends to cover the minimum RRIF withdrawal amount, while the spousal plan does not.
To avoid having to sell investments in the spousal RRSP to meet the minimum withdrawal requirement, I’m considering combining the two plans now, to ensure enough dividends are earned each year to cover the minimum RRIF withdrawal amount.
Do you see any problem with this? – George R.
Answer: There should be no problem. RRSPs can be combined if they have the same annuitant. That appears to apply here – you’re the annuitant of your personal plan as well as the spousal plan your wife created. The attribution rules do not apply since she has not contributed to the plan in the past three years.
--Gordon Pape
What’s up in the days ahead
Forestry earnings season starts Thursday. David Berman tells us what to expect from a sector generating tons of cash - and where the investment opportunities may lie.
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Globe Investor Staff
Editor’s note: An earlier version incorrectly stated the forward price to earnings ratio of the TSX 60 is 17 per cent lower than the S&P 500.