Canadian banks, oil producers, railways and pipelines look like fine sectors to ride out the economic turmoil ahead, given their mix of reasonable valuations, strong cash generation and rising dividends.
So, why not grab them all with a fund that tracks the S&P/TSX 60 Index?
The benefits of passive investing – a strategy based on accepting the returns of the market, rather than trying to outperform it with active stock selection – are well known.
But the appeal of Canada’s blue-chip index looks particularly strong in 2023, given the index’s exposure to companies that can survive an oncoming recession and reap the benefits of an economic recovery, all while paying out hefty dividends.
The S&P/TSX 60′s top stocks, based on their weightings, are like a wish list of solid performers, including Royal Bank of Canada RY-T, Enbridge Inc. ENB-T, Canadian National Railway Co. CNR-T and Canadian Natural Resources Ltd. CNQ-T.
The blue-chip benchmark does not have the diversification of the S&P 500. It doesn’t have the exposure to smaller companies that the S&P/TSX Composite Index delivers. And it lacks the global tech-stock dominance of the Nasdaq.
But none of these shortfalls looks like a bad thing right now, with higher interest rates weighing on tech stock valuations in particular.
The S&P/TSX 60 is also currently free of hype surrounding any particularly overvalued hot stock among its top holdings.
Recall that Valeant Pharmaceuticals International Inc. (now Bausch Health Cos. Inc. BHC-T), Research In Motion Ltd. (now BlackBerry Ltd. BBT), Potash Corp. of Saskatchewan Inc. (now Nutrien Ltd. NTR-T), Barrick Gold Corp. ABX-T and Nortel Networks Corp. all briefly dominated as Canada’s most valuable companies during remarkable rallies, only to fade soon after.
The most recent example, Shopify Inc. SHOP-T, overtook RBC as the country’s most valuable company in 2020. But Shopify’s shares have declined 64 per cent over the past 52 weeks, and it is now languishing as the 10th most valuable company.
But the best reason for considering a fund tied to the S&P/TSX 60 is the one-stop exposure to banks, energy, rails and pipelines, which appear well-suited to today’s economic backdrop.
Bank stocks have tumbled 15 per cent over the past year amid concerns about the Canadian economy and fears that rising borrowing costs will weigh on the country’s wobbling housing market.
But some analysts say that decline implies that a mild recession has been priced in already, and it has lifted the Big Six banks’ average dividend yield to nearly 4.8 per cent. As well, valuations, as measured by estimated price-to-earnings ratios, are below the historical average, giving the stocks the potential to deliver upbeat returns over the longer term as valuations improve.
Railways maintain indispensable transportation networks that can benefit this year from bumper crops, even if demand for commodities such as lumber subsides.
Pipeline operators Enbridge ENB-T and TC Energy Corp. TRP-T are compelling dividend plays, with yields of 6.4 per cent and 6.5 per cent, respectively. Both companies play a crucial role in traditional energy infrastructure that has taken on new significance over the past year.
Traditional oil producers have also roared back to life as lofty crude prices drive gargantuan profits, which large companies are distributing as bigger dividends as their debt levels decline.
“Among the many themes within the global energy landscape last year, none resonates more than the commitment of energy producers to return meaningful capital to shareholders,” Greg Pardy, head of global energy research at RBC Dominion Securities, said in a note this week.
Of course, you can buy any of these stocks individually (full disclosure: I own Enbridge shares and a fund that tracks the Big Six bank stocks, among other Canadian holdings).
But exchange-traded funds – such as the iShares S&P/TSX 60 Index ETF (ticker: XIU), a descendant of the world’s first ETF, launched in 1990 – have advantages that are hard to ignore.
Fees are slim: 0.18 per cent for the iShares fund, or $18 per year for every $10,000 invested. And academic evidence suggests that it is very difficult to outperform major indexes over time, even for professional stock pickers. That helps explain why the XIU fund has nearly $11-billion in assets.
“XIU has a significant amount of institutional usage. You have this critical mass of assets because of how widely used the product is,” Steven Leong, head of product for iShares Canada, said in an interview.
The S&P/TSX 60 is not immune to a deeper-than-expected recession, a downturn in commodity prices or further tumult in Canada’s housing market, which could cause volatility. But as an all-in-one bet on Canadian blue-chip stocks that will deliver results over the longer term, the index may be hard to beat.