Canadian equities set for growth despite recent underperformance

While Canadian equities have underperformed U.S. stocks this year, there are reasons to maintain a positive outlook, says a senior portfolio manager at CIBC Asset Management.

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CIBC’s Colum McKinley said the U.S. equity market’s recent performance has been driven by a narrow group of technology giants, including Nvidia, Tesla, Microsoft, Apple, Alphabet and Amazon. He said these companies have disproportionately influenced U.S. market returns, leading to a disparity in valuations.

“At the end of August, the valuation of U.S. stocks is much higher than Canadian stocks,” McKinley said in an interview on Aug. 31.

He pointed out that the S&P 500 was trading at a price-to-earnings ratio of about 19 times, above its 10-year average of 18 times. In contrast, the S&P/TSX composite traded at a price-to-earnings ratio of approximately 13 times, below its 10-year average of 15 times.

According to McKinley, this valuation gap is likely to correct itself over time, aligning more closely with historical averages.

“As a value investor, I think that’s one of the key ingredients to thinking about how the U.S. market and the Canadian market will perform over the coming years,” he said.

Another factor McKinley highlighted was the attractiveness of Canadian equities for income-oriented investors. He pointed out that in a low-interest-rate environment where investors seek attractive dividend yields, Canadian stocks offered an advantage. The S&P/TSX had a dividend yield of 3.3% at the end of August, while the S&P 500’s yield lagged at 1.5%.

“Dividend income is incredibly important to investors over the long term,” McKinley said.

High-quality dividend-paying stocks with sustainable growth prospects have rewarded investors, he said, and he anticipates the Canadian market’s dividend yield to continue to draw income-focused investors.

To realize the full potential of Canadian equities, McKinley noted the importance of key sectors, particularly energy and financials. He identified these sectors as trading at attractive valuations with compelling dividend opportunities.

Regarding the energy sector, McKinley said energy stocks are trading below historical valuations and generating strong cash flows, supported by favourable commodity price dynamics and disciplined capital management. He named Canadian Natural Resources Ltd. for its strong management team, substantial free cash flow and commitment to returning cash to shareholders.

Additionally, McKinley is optimistic about midstream and pipeline companies such as Enbridge, Gibson Energy and TC Energy. These companies offer highly predictable dividend streams and attractive current yields in the high single digits, he said.

However, McKinley acknowledged a risk related to interest rate increases, which could impact consumers’ purchasing power. He said the recent rapid interest rate tightening cycle, coupled with inflationary pressures, could challenge consumers and affect various sectors.

McKinley said that labour market tightness might mitigate some of these challenges but emphasized the importance of monitoring the evolving interest rate environment across portfolios and sectors.

Maddie Johnson

Maddie is a freelance writer and editor who has been reporting for Advisor.ca since 2019.