Canada's main stock market index surged to a record high on Friday following an upbeat jobs report and rising commodity prices, marking a stellar comeback for a market that was down on its heels just one year ago.
The S&P/TSX composite index closed at 15,729.12, up 111.82 points or 0.7 per cent, surpassing its 2014 peak. It joins major U.S. indexes that also touched record highs amid rising expectations for economic growth.
But the rebound by the Canadian benchmark stands out because it had fallen into a bear-market funk this time last year, when slumping commodity prices pushed the index toward a three-year low.
Banks, airlines and railways have contributed to the subsequent rebound over the past 12 months, but commodity producers have stood out with eye-popping gains as high as 700 per cent – giving index investors a particular thrill. The reason: Many professional stock pickers avoided beaten-up commodity producers when they were unloved.
However, index investors – who prefer to passively track the market rather than rely on clever stock picking to outperform it – have enjoyed the full rally.
Over the past 12 months, materials stocks have surged nearly 53 per cent, following an improvement in prices for everything from copper to zinc to nickel and a more recent uptick in the price of gold.
Some of the gains in this sector have been eye-popping. Ivanhoe Mines Ltd., which has a promising African copper project, has jumped more than 700 per cent over the past 12 months.
Teck Resources Ltd. and First Quantum Minerals Ltd. have risen more than 480 per cent over this same period.
Energy stocks – a deeply depressed group this time last year after the price of crude oil had fallen to a 13-year low of about $26 (U.S.) a barrel – have risen more than 37 per cent over the past year. Encana Corp., Enerplus Corp. and Bonavista Energy Corp. have all scored triple-digit returns.
How many investors saw this rally coming, given that some commodity producers were awash in losses and dangerous debt loads just a year ago?
Many of these high-flying companies now have absurdly high valuations: As a group, materials stocks trade at 60-times trailing profits and energy stocks trade at more than 100-times profits, according to Bloomberg.
If these stocks hit an air pocket, the index – and index investors – could suffer. But for now, mutual-fund portfolio managers who have less exposure to commodity stocks will struggle to keep up.
These managers form a large group. According to Morningstar, the average Canadian equity fund had 18.4 per cent of its assets in energy stocks at the end of 2016, or three percentage points less than the sector's weighting in the S&P/TSX composite index.
In the case of materials stocks, the differences are more striking. The average fund had just 7.8 per cent of its assets in these stocks. That compares to a 12 per cent weighting within the index. The vast majority of funds – about 85 per cent – have underweighted materials stocks.
Vijay Viswanathan, co-manager of the Mawer Canadian Equity fund, noted that his underexposure simply reflects a stock-picking approach that favours strong businesses, good management and value – what he calls his company's investment philosophy.
"It's not that we're dogmatic and made a sector call," Mr. Viswanathan said. "We just haven't found enough companies in the materials sector that fit our philosophy."
The Mawer fund has beaten the benchmark index over the latest five- and 10-year periods, suggesting that its stock-picking approach has worked well over the long term.
Over the past year, though, the fund has lagged the index, supporting the belief among passive investors that it is very hard to beat a stock-market index.
Standard & Poor's noted recently that less than a third of actively managed funds in the Canadian equity fund category have outperformed the S&P/TSX composite index over the past five years, after fees are factored in to returns. The percentage of winners falls to just 23 per cent over the past three years.
Last year proved no exception. According to Morningstar, the average Canadian equity fund delivered a return of about 18 per cent, lagging the composite index by 3 percentage points, after dividends are included.
With materials stocks continuing to deliver the biggest gains in 2017 – they have risen 15 per cent in six weeks – index investors may have one more reason to gloat.