Weird correlation of the day: The S&P/TSX Composite performance closely resembles emerging markets benchmarks. Canadians looking to predict the course of equities in 2013 would do better to look to Asia rather than other developed nations. (I warned you it was weird.)
The chart above shows the stunning 0.935 correlation between the domestic benchmark and the MSCI Emerging Markets Index. That's distinctly different from the result of a similar calculation for the U.S.; by comparison, the same measure for the S&P 500 and MSCI EM is 0.593. Thankfully, the S&P/TSX is less than half as volatile as the MSCI benchmark, according to standard deviation, but nonetheless, the high correlation is an uncomfortable notion for Canadians who would much rather associate our economy with those of the other G7 countries.
There is, however, a simple explanation – the dominance of resource companies in the Canadian domestic benchmark is the primary reason for the relationship. Energy and materials stocks make up 44 per cent of the index. When emerging markets economies are growing, the increased demand for resources translates into higher commodity prices and stock values in these sectors.
It is important to remember that the Canadian economy and the equity market are by no means the same thing, and that economic growth is much more tied to the United States. Investors focused on the equity market, however, will need to incorporate a forecast for emerging markets as part of their investment strategy.
Scott Barlow