Why Canadian equities are poised for a rebound

It’s no secret that Canadian equities have faced a lacklustre start to the year compared to the robust performance of the S&P 500 and the Magnificent Seven (Meta, Microsoft, Nvidia, Apple, Alphabet, Amazon and Tesla) . 

However, Craig Jerusalim, senior portfolio manager with CIBC Asset Management, said this underperformance is not due to weak earnings growth.

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Based on earnings season so far, Jerusalim said in an interview on Feb. 16, the TSX has delivered at least as strong earnings growth relative to its U.S. counterpart. This, combined with price underperformance, has led to the TSX trading at its widest discount to the S&P 500 on a forward price-to-earnings basis than seen in the past few decades.

“The more cyclical composition of the TSX has been … holding the TSX back,” Jerusalim said. 

Now, with “green shoots starting to emerge for global growth,” he said, the stage is set for a potential sharp rebound in sectors such as energy and materials, which could help close the relative valuation gap with the S&P 500.

Another factor contributing to the outperformance of U.S. equities over Canadian ones, Jerusalim said, is the hype surrounding artificial intelligence (AI). 

There are lots of reasons to want exposure to AI, Jerusalim said; he likened the AI theme to being in the batter’s box, with room for growth and productivity enhancements to come. “We haven’t even started the game,” he said. “The umpires aren’t even on the field yet.”

While acknowledging that the purest exposure to AI is found in U.S. companies, Jerusalim said several Canadian leaders are well-positioned to benefit from the AI trend. He categorized these companies into three groups: those with direct exposure to AI, companies enabling or facilitating AI gains, and those enabling or benefiting from AI growth.

Among Canadian companies, Jerusalim said Shopify stands out for its direct exposure to AI through tools like Shopify Magic and Sidekick, which enhance e-commerce productivity. He cited companies such as Thomson Reuters, Docebo, Dye & Durham, Kinaxis, OpenText and CGI as companies leveraging AI to drive revenue growth and cost reduction, or positioning themselves strategically within the AI infrastructure landscape.

So, despite the valuation gap between Canadian and U.S. equities, he’s optimistic about the medium-term outlook for Canadian equities. 

He said that as global growth improves, cyclical sectors rebound, and Magnificent Seven stock prices return to more normal levels, there is potential for a reversion to the mean for both the TSX and the S&P 500, indicating further relative outperformance for Canadian equities.

However, Jerusalim cautioned against the risk of excessive valuation driven by AI hype and excitement, and he drew a parallel with the technology bubble of the late 1990s. 

Still, he was positive on the earnings and growth potential of Canadian companies in the AI space, and he emphasized the importance of monitoring valuation while capitalizing on the potential for explosive growth in the early stages of the AI trend.

“I will say that, even if we are entering the bubble, we are likely in the early stages of the bubble, which means that there is still the potential for explosive growth in these companies that we don’t want to be missing out on,” Jerusalim said. 

This article is part of the Advisor To Go program, powered by CIBC Asset Management. It was written without input from the sponsor.