Where are Canadian equities headed?

After outperforming U.S. markets last year, Canadian equities are now struggling to keep pace amid a surge in tech stocks and the return of FOMO.

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Greg Zdzienicki, client portfolio manager at CIBC Asset Management, attributed the divergence to the dominance of information technology and select consumer discretionary stocks in the U.S., particularly those leveraging artificial intelligence (AI) capabilities.

The second quarter of this year saw an unexpected surge in these sectors, driven by the excitement surrounding AI and a touch of FOMO (fear of missing out) among investors, he said.

While the Nasdaq celebrated its strongest first-half performance in four decades, the S&P/TSX composite index saw more subdued growth. This discrepancy, Zdzienicki said, can be attributed to the differing compositions of the two markets, with the Canadian index weighed down by cyclical sectors such as gold stocks, real estate investment trusts (REITs) and consumer staples.

Further, he said underperformance of Canadian equities isn’t merely due to technological prowess in the U.S. markets but also valuation differentials. U.S. equities are trading well above their long-term average valuations due to the high-growth mega-cap tech stocks, he said.

On the other hand, Canadian equity valuations are below their long-term averages, partly due to the prevalence of cyclical energy and bank stocks. This valuation gap suggests a potential opportunity for Canadian equities to revert closer to their historical averages. Moreover, Canada boasts several strengths, Zdzienicki said, including a robust banking system, exposure to energy and a progressive immigration policy that could drive future growth.

Zdzienicki said he remains optimistic about the Canadian equity market’s prospects. “When you compare Canada to the U.S. and to the rest of the world, we’ve seen some underperformance, but we still remain very constructive on Canadian equities,” he said.

Zdzienicki said he continues to be overweight in the market, particularly in sectors such as financials, energy and industrials.

The banking sector, which faced turmoil in the U.S. following the failure of Silicon Valley Bank, appears more stable in Canada, Zdzienicki said. He pointed to Canadian banks’ resilience in the face of headwinds like rising provisions for credit losses and higher capital requirements.

“At the beginning of the second quarter, I think we were a little bit more bearish on the banks, but then moved a little bit more bullish as a lot of this has been priced in and factored in,” he said.

Looking at Canadian equities more broadly, Zdzienicki said the impact of potential rate hikes remains a concern. As interest rates increase, the cost of capital rises, potentially leading to a higher required rate of return on investments and affecting equity prices. Therefore longer-duration assets, like some technology stocks, may face further challenges due to increasing discount rates.

Higher rates also impact consumer spending, which could cut into company earnings.

“I don’t think we’ve actually avoided the recession,” Zdzienicki said. “We’ve probably just delayed the recession to some point in the future.”

Maddie Johnson

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