The Canadian economy is export oriented and resource rich, so it’s no surprise that the S&P/TSX Composite Index has been sensitive to changes in global trade activity. In recent years, the relationship between Asian trade volume and the TSX has been particularly close.
The news from that front has not been great, threatening the recent rally in Canadian equities.
The most widely used benchmarks for global and regional trade are compiled by the Netherlands Bureau for Economic Policy Analysis (CPB). The first accompanying chart shows the year-over-year change in the CPB World Trade Index and the annual change in the S&P/TSX Composite.
For much of the past decade, the rate of change in global trade activity was far lower than the domestic equity market. From early 2018 to August, 2019, however, dips and recoveries in trade activity were generally matched by equities in a much more pronounced fashion.
The past three months have seen the S&P/TSX move higher while the global trade index continued to deteriorate. The year-over-year decline in trade has fallen to levels last seen in 2009.
The performance of domestic equities has tracked Asian trade volumes much more closely than global trade as a whole, as the second chart highlights. China is the primary reason for this, as the dominant source of demand for the majority of the world’s commodities. Even if domestic miners and energy producers don’t sell directly to Asia, Chinese demand determines commodity price changes that affect their profit growth.
Asian trade volume is declining in year-over-year terms because of the U.S.-China trade dispute and the resulting tit-for-tat tariffs, but is not at decade lows like global trade. The same divergence on the second chart is apparent – Canadian equities have been stronger than trade data suggest they should be.
The divergence is likely to close in 2020, in one of two ways. The positive scenario is for trade data to improve – the blue line (in both charts) will climb to meet the S&P/TSX’s growth path. Any partial resolution of the U.S. tariff issues would be extremely helpful in this regard. U.S. President Donald Trump said on Tuesday that the country and China were close to agreement on the first phase of a trade deal. In the meantime, new U.S. tariffs are supposed to take effect on Dec. 15.
The risk for investors is that the expected rebound in trade that has helped push markets higher fails to materialize. Peter Oppenheimer, chief global equity strategist at Goldman Sachs, warned of this scenario in a Tuesday research report. Mr. Oppenheimer said that his company’s global economic growth forecast predicted modest gains for 2020, but that “a good deal of this prospective recovery has already been reflected in the strong equity rebound,” creating the distinct possibility of negative surprises.