Canadian investors are justifiably frustrated in an environment where domestic economic growth rockets ahead while the S&P/TSX composite index stubbornly treads water. Analysis by Bank of Montreal chief economist Doug Porter implies, however, that all investors might have to do is wait.
The first chart below, recreated from Mr. Porter's work, compares year-over-year gross domestic product growth with the year over year move in the equity benchmark – and the chart is bullish. Note that the index returns are lagged two months, and the resulting correlation strongly implies that domestic equities follow GDP growth with the same 60 day delay.
The divergence at the end of the data sets suggests that the purple line representing year-over-year equity returns is set to jump higher, reflecting the recent surge in reported economic growth.
To extend BMO's analysis, I measured year-over-year performance of all major S&P/TSX equity subindexes versus GDP growth to uncover the market sectors likely to benefit most from economic improvement.
I strongly expected that bank stocks would be most correlated to the economy but telecom-services stocks were the winners, as shown in the second chart.
Importantly, the relationship between economic growth and telecom stocks has been tight in the last few years, but much less so in the precrisis years – investors should view recent results with a grain of salt. That said, the chart does imply strong performance for telecom stocks in the coming months.
The media sector was the second most sensitive to economic growth and at first this was a major surprise. A closer look at four of the six companies in the subindex, however, makes things more understandable.
Quebecor Inc. and DHX Media both benefit from the surge in advertising and marketing spending that accompanies a strengthening economy. Cogeco Communications Inc. and Shaw Communications Inc. are closely aligned with the telecommunications companies represented in the earlier chart. (The other two companies in this subindex are Cineplex Inc. and Corus Entertainment Inc.)
The connection between economic growth, telecom and media stocks is visible on the charts but it's not consistently strong enough to make investment in these sectors anything like a guarantee of strong returns. But for investors looking for stocks likely to benefit from accelerating growth, these industries are a great place to start the research process.
Scott Barlow