The domestic equity market is increasingly reliant on one stock – Valeant Pharmaceuticals International Inc. – for positive performance and, as a result, the benchmark is starting to resemble a full 747 flight with only one working engine.
The S&P/TSX composite index is down 206 points or 1.4 per cent year to date as of Aug. 7. Valeant, which has almost doubled in value so far in 2015 (the stock is up 97 per cent), is almost single-handedly preventing a much deeper downdraft for the benchmark.
Valeant has contributed 406 positive points to index performance, according to Bloomberg. The second-biggest positive contributor to index returns, Brookfield Asset Management Inc., has added 47 points to the benchmark this year. Valeant's positive influence on the benchmark has been nine times the size of the next most positive contributor.
The insider term for indexes with few positive stocks is "narrow breadth." It's not healthy in the same way no one wants to fly in a plane with one engine. Preferably, an index would have numerous stocks driving the levels higher so that if one falters, others can pick up the slack.
The chart below underscores the trend. It compares the market-capitalization-weighted S&P/TSX composite (the most commonly used equity benchmark) with the equal-weighted TSX index.
In the S&P/TSX composite, larger cap stock performance has a much larger effect on benchmark performance than smaller companies. A 1-per-cent rise in Royal Bank of Canada, for instance, would have more than 10 times the upward effect on the index compared with Canadian Tire Corp. Ltd. or Fortis Inc. In the equal-weighted index, all companies have the same impact, regardless of size.
When the equal-weighted TSX index drastically underperforms the market-cap-weighted benchmark, this indicates weaker market breadth. It means the TSX composite is dependent on a few larger companies for its returns. When equal-weighted index performance is equal to, or better than, the cap-weighted benchmark, a larger percentage of stocks in the market are performing well, helping push the index higher.
The Valeant-driven outperformance of the market-cap-weighted S&P/TSX composite relative to the equal-weighted index has been dramatic. The composite index has fallen a marginal 5.7 per cent over the past twelve months while the equal-weighted index is officially in bear market territory – down 20.6 per cent.
The vast majority of Canadian stocks are sharply lower in the past year, but in the S&P/TSX composite index, much of the damage has been covered up by the tremendous surge in megacap Valeant.
In short, the market is in much worse shape than benchmark performance suggests. Investors who do not own Valeant are likely to be trailing the index by a wide margin and wondering why. Professional money managers are likely grinding their teeth in frustration. They almost have to hold Valeant whether they want to or not – otherwise they risk trailing the index by an amount large enough to threaten their employment.
The last TSX stock to dominate the index like this was Nortel Networks, but that doesn't mean the same type of painful downdraft is guaranteed for the market. It does, however, mean the Canadian market is fragile until more stocks start helping out with positive performance.
Follow Scott Barlow on Twitter @SBarlow_ROB.