Canadian investors of late have been pouring assets into U.S. equities at a near-record pace. While it’s not difficult to see the attraction, it’s also very easy to see why investors might be making a huge mistake.
Ben Randol, a foreign exchange strategist at B of A Securities, analyzed Canadian cross-border investment data for the fourth quarter of 2020 in a Feb. 17 report (the data were released by Statistics Canada on the same day).
“Canada’s net portfolio investment balance with the rest of the world exploded to a [deficit of] C$21.9-billion for the period,” he pointed out.
The vast majority of this deficit arose from Canadians buying $20-billion more in foreign equities than foreign investors bought Canadian stocks. Mr. Randol noted persistent Canadian demand for U.S. securities in particular: $82-billion in U.S. stocks was purchased domestically between April and December, 2020 (all dollar figures Canadian).
Domestic investors were clearly looking in the rearview mirror by the end of 2020. At that point, the trailing 12-month total return on the S&P 500 was 16.5 per cent in Canadian dollar terms – 10.9 percentage points ahead of the S&P/TSX Composite appreciation. It is not a surprise that investors were chasing performance by buying U.S. stocks at that time.
Market conditions in 2021 have changed in favour of the Canadian equity benchmark. So far this year, the S&P/TSX’s 5.5-per-cent total return has significantly outpaced the S&P 500′s 2.3-per-cent rise in Canadian dollars. This month alone has seen the domestic benchmark’s 5.9-per-cent jump easily outdistance the 3-per-cent S&P 500 return in Canadian dollar terms. (Note these time frames are slightly different than those in the accompanying chart.)
A closer look at recent sector performance for the more diversified S&P 500 provides considerable insight into why the tides have turned. The second accompanying chart shows that month-to-date, the top performing sectors are the ones where the TSX has a far larger weighting than the U.S. benchmark.
Energy has been the top performing U.S. market sector in February, climbing a remarkable 23.6 per cent, to Tuesday’s close. Energy stocks account for 2.7 per cent of the S&P 500 but a whopping 12.1 per cent of the S&P/TSX Composite. The strength in global energy stocks is therefore far more beneficial to domestic index returns, helping the S&P/TSX Composite to outperform.
The picture is similar for financials, the second-best performer within the S&P 500. U.S. financial stocks have jumped 13.5 per cent so far this month. Again, the Canadian equity benchmark has a far bigger weighting in financial stocks at 29.6 per cent of the index versus 10.8 per cent of the S&P 500.
There’s little doubt that when Statscan releases cross-border investment data for the first quarter of 2021, the evidence will show that the pace of U.S. equity buying is slowing as Canadian investors recognize the pro-domestic market shift.
Still, trends like this can be persistent (or in finance industry terms, “sticky”). Importantly, many investment decisions during RRSP season in particular are affected by trailing 12-month returns, and the Canadian-dollar S&P 500 total return over the past year remains superior to the TSX. The U.S. benchmark climbed 16.4 per cent in loonie terms, more than double the S&P/TSX Composite’s 7.9 per cent appreciation.
The developed world’s continuing recovery from full quarantine conditions implies that Canadian equities will continue to outperform. The economically sensitive sectors – materials, energy, financials and industrials – that the TSX carries in abundance are likely to outpace the expensive technology stocks that dominate U.S. markets.
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